In 1967, a Chicago bank refused a college professor by the
name of Milton Friedman a loan in pound sterling because he had
intended to use the funds to short the British currency. Friedman, he
had perceived sterling to be priced too high against the dollar, wanted
to sell the currency, then later buy it back to repay the bank after
the currency declined, thus pocketing a quick profit.
The bank's refusal to grant the loan was due to
the Bretton Woods Agreement, established twenty years earlier, which
fixed national currencies against the dollar, and set the dollar at a
rate of $35 per ounce of gold. The Bretton Woods Agreement, set up in
1944, aimed at installing international monetary stability by
preventing money from fleeing across nations, and restricting
speculation in the world currencies Prior to the Agreement, the gold
exchange standard--prevailing between 1876 and World War I--dominated
the international economic system.
Under the gold. exchange, currencies gained a new phase of
stability as they were backed by the price of gold. It abolished the
age-old practice used by kings and rulers of arbitrarily debasing money
and triggering inflation. But the gold exchange standard didn't lack
faults. As an economy strengthened, it would import heavily from abroad
until it ran down its gold reserves required to back its money. As a
result, money supply would shrink, interest rates rose and economic
activity slowed to the extent of recession.
Ultimately, prices of goods had hit bottom,
appearing attractive to other nations, which would rush into buying
sprees that injected the economy with gold until it increased its money
supply, and drive down interest rates and recreate wealth into the
economy. Such boom-bust patterns prevailed throughout the gold standard
until the outbreak of World War I interrupted trade flows and the free
movement of gold. After the Wars, the Bretton Woods Agreement was
founded, where participating countries agreed to try and maintain the
value of their currency with a narrow margin against the dollar and a
corresponding rate of gold as needed.
Countries were prohibited from devaluing their
currencies to their trade advantage and were only allowed to do so for
devaluations of less than 10%. Into the 1950s, the ever-expanding
volume of international trade led to massive movements of capital
generated by post-war construction. That destabilized foreign exchange
rates as set up in Bretton Woods. The Agreement was finally abandoned
in 1971, and the US dollar would no longer be convertible into gold. By
1973, currencies of major industrialized nations became more freely
floating, controlled mainly by the forces of supply and demand which
acted in the foreign exchange market.
Prices were floated daily, with volumes, speed and
price volatility all increasing throughout the 1970s, giving rise to
new financial instruments, market deregulation and trade
liberalization. In the 1980s, cross-border capital movements
accelerated with the advent of computers and technology, extending
market continuum through Asian, European and American time zones.
Transactions in foreign exchange rocketed from about $70 billion a day
in the 1980s, to more than $1.5 trillion a day two decades later. The
Euromarket A major catalyst to the acceleration of foreign exchange
trading was the rapid development of the euro-dollar market; where US
dollars are deposited in banks outside the US.
Similarly, Euromarkets are those where assets are
deposited outside the currency of origin. The Eurodollar market first
came into being in the 1950s when Russia's oil revenue-- all in dollars
-- was deposited outside the US in fear of being frozen by US
regulators. That gave rise to a vast offshore pool of dollars outside
the control of US authorities. The US government imposed laws to
restrict dollar lending to foreigners. Euromarkets were particularly
attractive because they had far less regulations and offered higher
yields.
From the late 1980s onwards, US companies began to
borrow offshore, finding Euromarkets a beneficial center for holding
excess liquidity, providing short-term loans and financing imports and
exports. London was, and remains the principal offshore market. In the
1980s, it became the key center in the Eurodollar market when British
banks began lending dollars as an alternative to pounds in order to
maintain their leading position in global finance. London's convenient
geographical location (operating during Asian and American markets) is
also instrumental in preserving its dominance in the Euromarket.
