Fiat or Floating Currency – Fiat currency is the opposite of a gold standard arrangement. In a fiat currency system, the currency’s value rises and falls on the market in response to demand and supply pressures. It is this fluctuation that makes it possible to speculate on future currency values.

The Bretton Woods Agreement, established in 1944, fixed national currencies against the dollar, and set the dollar at a rate of 35USD per ounce of gold.

In 1967, a Chicago bank refused to make a loan in pound sterling to a college professor by the name of Milton Friedman because he had intended to use the funds to short the British currency. The bank’s refusal to grant the loan was due to the Bretton Woods Agreement.

This agreement aimed at establishing international monetary steadiness by preventing money from taking flight across countries, and curbing speculation in the international currencies.

Prior to Bretton Woods, the gold exchange standard – dominant between 1876 and World War I – ruled over the international economic system. Under the gold exchange, currencies experienced a new era of stability because they were supported by the price of gold.

However, the gold exchange standard had a weakness of boom-bust patterns. As an economy strengthened, it would import a great deal until it ran down its gold reserves required to support its currency.

As a result, the money supply would diminish, interest rates escalate and economic activity slowed to the point of recession.

Ultimately, prices of commodities would hit bottom, appearing attractive to other nations, who would sprint into a buying fury that injected the economy with gold until it increased its money supply, driving down interest rates and restoring wealth into the economy.

Such boom-bust patterns abounded throughout the gold standard until World War I temporarily discontinued trade flows and the free movement of gold.

The Bretton Woods Agreement was founded after World War II, in order to stabilize and regulate the international Forex market.

Participating countries agreed to try to maintain the value of their currency within a narrow margin against the dollar and an equivalent rate of gold as needed. The dollar gained a premium position as a reference currency, reflecting the shift in global economic dominance from Europe to the USA.

Countries were prohibited from devaluing their currencies to benefit their foreign trade and were only allowed to devalue their currencies by less than 10%. The great volume of international Forex trade led to massive movements of capital, which were generated by post-war construction during the 1950s, and this movement destabilized the foreign exchange rates established in the Bretton Woods Agreement.

1971 heralded the abandonment of the Bretton Woods in that the US dollar would no longer be exchangeable into gold. By 1973, the forces of supply and demand controlled major industrialized nations’ currencies, which now floated more freely across nations. Prices were floated daily, with volumes, speed and price volatility all increasing throughout the 1970s, and new financial instruments, market deregulation and trade liberalization emerged.

The onset of computers and technology in the 1980s accelerated the pace of extending the market continuum for cross-border capital movements through Asian, European and American time zones. Transactions in foreign exchange increased intensively from nearly $70 billion a day in the 1980s, to more than $1.5 trillion a day two decades later.