Brief History of Foreign Exchange
Foreign exchange has been around as long as transactions have involved crossing country borders. No doubt, trade took place even before national boundaries and modern currencies existed. But once a country or region established a money of their own, then currency transactions became necessary. (Strictly speaking, this need not always have been the case if the two currencies were convertible. In other words, if two countries both used gold coins and the values of those coins were based entirely on the weights of the metal they contained, then there should have been a single exchange rate between those currencies).1
Although there are many interesting accounts of the early forms of money2
(dealing primarily with the use of precious metal in the form of coins), the fundamental economic principle on this topic typically goes by the name of Gresham’s Law. Thomas Gresham, in 1558, stated that bad money always drives out good money. What this means is that currency which has been debased (such as clipped or “sweated” coins or coins made of an inferior or lower precious metal content) tends to drive “better money” (whole coins or coins with a higher metal content) out of circulation (i.e., induce hoarding). When was the last time you saw a “real silver” U.S. dime, quarter, or half-dollar? John Kenneth Galbraith wrote, “It is perhaps the only economic law that has never been challenged.”3
Prior to 1900, most national ...