Foreign exchange today may seem too complex for the average person
to grasp. The images of the market that dominate the media—
walls of blinking computer screens, screaming traders, giant blocks
of money traded at the speed of light, defined by an intricate interplay
of events—reinforce this perception. But these images are
actually part of a façade, masking a relatively simple transaction.
At its heart, each foreign exchange is a trade—an exchange of
one monetary unit (currency) for another. Dealers and investors
may employ intricate strategies or use technical trading language
and develop rich models, but that doesn’t fundamentally alter
the act.
Understanding this helps cut through the clutter, misperceptions,
and mystery that surround this market. Very little of what is
done in foreign exchange today is vastly different from how individuals
have traded for thousands of years. The techniques and
tools have changed, but the simple exchange remains the same.
Because foreign exchange is in fact so old, it is important to
trace its roots, to explore how this market has evolved over the
millennia. Individuals—kings and emperors, traders and dealers,
common citizens and thieves—have employed all kinds of methods
to use money and markets to their advantage. Their strategies
have resulted in success and disaster. But all contain examples and
lessons that will be helpful for the modern investor to understand
this market.
Lessons of History
One of the most famous and vivid channels of foreign exchange
occurred along the fabled “Silk Road”—over which goods flowed
back and forth between Asia, the Middle East, and Europe. The
road started in Xian, a city in central China, and went by various
trails west. Centuries ago, traders prodded columns of camels
loaded with rugs, silks, and bags of aromatic spices that
Europeans needed to season their dishes and delight their palates.
Through the city’s alleys and in its open market spaces, goods
were inspected, values suggested, and deals struck. Money and
objects changed hands.
This kind of trade is the barter system, which is still the norm
in many parts of the world. However, the barter system had flaws.
For one, making individual trades was cumbersome and time-consuming.
Each item had to be inspected and its worth determined
before haggling could even begin.
Two, it was inefficient. Goods didn’t always match up in value,
so bartering required an extensive number of items to make the
trade even. A bag of grain may not be exactly worth a lamb, so the
trader would have to add a bottle of wine to even things out. This
made things much more complex.
Three, the barter system could leave out vast parts of society.
What happens if the farmer wants meat but doesn’t need a pair of
shoes? The farmer trades his grain with the butcher. But the shoemaker,
who needs grain as much as the butcher, is left out.
There is a solution to the problems of the barter system, and
many cultures developed it—currency.
The Roots of Modern Currency
Forget the idea that currency is a piece of colored paper with a picture
of someone famous on it. Paper money as it now exists is a relatively
new concept, and it probably won’t survive our lifetimes. In
cultural and historical terms, currency is something that any group
mutually recognizes as valuable.
For example, the Aztecs prized cacao beans, which were used
to make a delicious chocolate drink. Part of the beans’ value
derived from the fact that they were also practical. They could be
transported relatively easily, were uniform, and made bartering simpler.
If a trade was uneven, a merchant could throw in a scoop or
two of beans.
The ancient Romans valued salt, an essential spice to liven up
dishes and replenish the body during hot Mediterranean summers.
Like the Aztec cacao beans, salt was also practical. It could
be cut into small, uniform units and was accepted everywhere.
Roman soldiers, who sweated during maneuvers under their
leather and armor, were paid in salt. The Latin word for salt, sal,
is the root of salary.
In North America, we still refer to one dollar as a buck—few
understanding that buck once referred to deerskin, which was commonly
used as an item of exchange in colonial times.
Everywhere, currency was determined by local conditions. East
Asians often used rice, Mongolians used bricks of tea, and Native
Americans in the Northeast used colored shells.
The introduction of currency marked an important advance in
a society’s economic life. Instead of simply trading items, people
could determine value through something universal. Currency
allowed exchanges to be more circular, rather than a chain of oneon-
one transactions. The shoemaker could now sell his wares to
the butcher for currency and then use that currency to buy the
grain he needed.
Value, of course, is a relative term, and cultures often found
that what they treasured did not inspire the same reverence in their
neighbors. One tribe in Alaska used dog teeth as currency, something
other tribes regarded as disgusting. The aristocrats of Yap, an
island in the South Pacific, used giant sandstone slabs so large that
they needed dozens of laborers to move them. For obvious reasons,
this currency never gained wide use.
As ancient cultures grew more sophisticated and trade grew to
unprecedented levels, they found themselves back in the same
barter system as before, with all its faults. The problem was to find
something that was recognized as valuable, even among different
cultures with different languages and beliefs.
The solution to this problem appeared in 640 BC in a civilization
on the coast of what is today Turkey. This invention would
establish the first international currency and lay the groundwork
for our modern economic system—the metal coin.
The small kingdom of Lydia had grown rich through its production
of high-quality cosmetics and perfumes, which it sold to
other lands throughout the eastern Mediterranean.
The Lydians were the first, it appears, to mint coins. Metal, of
course, had long been recognized as a valuable substance by many
cultures. Gold, with its alluring luster, its malleable quality, and the
fact that it never rotted or rusted, was held in high esteem. As early
as 2500 BC, Mesopotamian clay tablets carried inscriptions that
recorded the use of silver and gold as payments. But these payments
were usually in large quantities. Gold was too scarce and
valuable to be used in small exchanges.
This changed when the Lydians began stamping the first coins,
which were about the same size as a modern quarter but much
thicker. Several could be easily carried around in a bag. These first
coins were made from a naturally occurring mixture of gold and
silver called electrum. To make sure everyone, including illiterate
farmers, could determine the value of the coins, the Lydians
stamped them with a lion’s head.
It is difficult to overestimate the impact these coins made as
they began to circulate among the empires that ringed the
Mediterranean Sea. Uniform coins meant merchants did not have
to use scales to measure metal, a time-consuming process. A glance
could determine literally how much money was on the table. Even
in 600 BC, traders knew the importance of time and convenience.
Lydia produced more coins, with newer versions fashioned of
solid gold. Money begot money. Attracted by the standard coins,
merchants began setting up their goods in a central spot where people
could browse among different stalls for goods—dishes, beer,
olive oil, cloth. The market, not unlike the modern shopping mall,
was born.
Although the Lydian empire soon crumbled, its innovation in
using coins spread through the Mediterranean world. This was the
first international economic system as we would understand it.
It is here that we can first see the revolutionary impact that
money has had on society. Most ancient groups were small and
organized around the principle of kinship. Going outside that society,
because of fears, xenophobia, and misunderstandings, was
rare. Most transactions involved one person speaking to another.
The value of money in the form of coins, however, was recognized
between cultures. You did not need to speak the same language
or have the same cultural background. Thus, societies could
easily join and create an economy far more complex, diverse, and
large than anything seen before.
In the late fourth century BC, Alexander the Great led his
armies to victory through central Asia and into India. Alexander’s
empire was, for the first time in history, a commercial empire.
Alexander did not just demand tribute from the conquered peoples.
He yoked them into a new economic order by building cities with
open markets in their center. Merchants quickly moved in, using
the trusted Greek coins as a medium of exchange. The Greek language,
in a heavily accented, simplified form, was used by merchants
of different cultures to haggle and exchange goods.
These characteristics are not too dissimilar from the world
today, where international business is largely based on the dollar
and deals made after a discussion in pigeon English. Alexander’s
period could be called the first era of globalization. Our modern
era, with its markets and means of exchange, is not fundamentally
different.
Source: The History of Forex Market And Why You Should Care
