08 August 2013

Forex - A History of Currency Exchange: The Nixon Shock

Whilst it is not necessary to understand the origins of forex in order to trade successfully in this market, knowledge of how forex emerged from what went before can provide some potentially beneficial insights. In part 1 of this series of articles we looked at the birth and death of the Bretton Woods Agreement. In this second part we will look at its final death blow, and what happened next.

The Bretton Woods Agreement, which was set up to facilitate international trade by pegging international currencies to the dollar and the dollar to gold, fell apart at the seams in the early seventies. Its final death blow has come to be known as 'The Nixon Shock'. Faced with galloping inflation and massive costs due to the war in Vietnam, the US economy was in dire straights. Because the gold price on the open market was higher by several dollars than the dollar pegged gold rate of $35 per ounce, people were trading dollars for gold which they were then selling on the open market. Gold was fleeing the country and the economy was in serious deficit.

West Germany, wary of catching inflation from the US, pulled out of the Bretton Woods Agreement. This resulted in an increase in the value of the German Mark by 7.5% against the dollar. Suddenly there was a run on gold as nations traded paper dollars for the metal. To stave this off the US devalued the dollar, however it was too little and too late, and Switzerland also pulled out of Bretton Woods.

The US was getting desperate. President Nixon imposed a range of emergency measures that included a three month freeze on prices and wages, a surcharge on all imports, and ended the dollar gold parity set forth in the Bretton Woods Agreement. No longer could nations demand gold in exchange for their paper dollars.

Rather than a total currency exchange free for all, it was felt that new regulations were needed, and the Nixon Shock was followed by an attempt to shore up the system. This new arrangement, known as the Smithsonian Agreement, pegged the dollar to $38 per ounce of gold and increased the parity to plus or minus 2.5%; however it failed in its aim and this failure led to Forex.


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