by Duane Davis

The process of exchanging value for products and services between countries started centuries ago primarily between Asia, the Middle East and Europe.  Merchants from Arabia would caravan camels that were loaded down with rugs, silks and spices.  Once they reached a city they’d sell their products in open market places.  The method used in those days to establish a value was the bartering system.  This same system is still used today in different parts of the world.

The problem with the barter system is that it’s slow.  Items have to be dealt with one at a time.  The seller’s time is tied up with the purchaser carefully inspecting the merchandise before the two of them begin to haggle until they reach an agreed upon price.  Prior to the invention of coins, items of similar value had to be exchanged.  If a bag of spices, for example, didn’t equal a cut of meat, the buyer or seller might have to throw in a bag of rice.  Eventually, mankind solved the problems with the barter system with the invention of ‘currency’.

In some cultures, ‘currency’ consisted of beads.  In others, it was animal skins or colored shells.  But whatever the currency, because most inhabitants in an area used the same thing, it made buying and selling much easier.  But what was seen as currency in one culture, did not necessarily have the same value to a different culture.  As these different cultures became more sophisticated, it eventually led to the invention of metal coins.

For more than a thousand years, some cultures used small ingots of Gold, Silver and Copper as their currency.  The first coins appeared around 640 B.C. in what is now the country of Turkey.  The use of coins made commerce between cultures much easier than weighing and exchanging bags of ingots.  As the use of coins grew in popularity, the first economic financial system was born.

Eventually, coins made from valuable metals such as gold and silver were replaced by tokens which were made from brass or other less valuable metals.  These tokens were manufactured and controlled by governments whose citizens were forced to accept them and respect their individual ‘implied’ values.  To compare this to our system today, we know that two nickels are worth one dime and that four quarters are equal to one dollar.

Instead of coins or tokens, a Chinese invention of paper and printing was used to represent a quantity of gold or silver that was held by the government.  The bearer of the new ‘paper currency’ could, at any time, exchange it for the gold or silver that it represented.  Buyers and sellers found it much easier to carry large sums of this new paper currency.  It was much easier than carrying around bags of coins or tokens.  The problem with this system was that it was controlled by the government and if the government wanted to print more paper money than they had in gold and silver deposits, the currency would become worth less and less.  For the citizens and merchants of that area, the printing of more money wasn’t that big of a problem because everyone was basically affected in the same way.  It did however, become an issue when good and services were exchanged between countries.

The use of paper money meant that the stability of a government had a direct affect on the value of its currency.  The more stable a government, the more valuable the currency.  Currencies of stable governments were in higher demand.  The higher demand, however, was often offset by an excess of supply due to the over printing of the paper money.  Although the Foreign Exchange Market didn’t exist at the time, wealthy individuals that understood the stability of one government versus another and the supply and demand that existed with a government’s currency, were able to make fortunes.

The Modern Gold Standard

In 1944, in the state of Vermont, the world Gold Standard was created when all western currencies were tied to the US Dollar.  Thus, the British Pound, the French Franc and the German Mark were all tied to the US Dollar.  And, more important, the US Dollar was backed by a certain amount of Gold.  After surviving two world wars, the economies of the world were in desperate need of a sound currency system.

By the 1960’s however, the Gold Standard was in trouble as more and more US Dollars were printed and placed into circulation.  Finally, in 1971, President Nixon announced that the Gold Standard was no longer effective due to the fact that there wasn’t enough gold to back the quantity of US Dollars in circulation.  For 27 years, the Gold Standard did a terrific job of giving confidence and lending credibility to the free world as it struggled from the devastation of two major world wars.  Although it was a very good system for its time, today’s free market system is even better and now with the advent of the Foreign Exchange Market (or Forex), it’s possible for everyone to participate in the exchange of foreign currencies.