FX International Payments
By Frances Coppola
It is often said that the common “currency” of antiquity was gold or silver. But gold and silver are soft metals that are easily eroded if not alloyed with a base metal. The coins and bars used for trade were therefore never pure gold or pure silver. There were no common assay standards and thus no reliable means of establishing the precious metal content of a bar or coin. The proportion of gold or silver in the coin or bar therefore varied depending on where it was issued, and that proportion was not always evident. International trade was restricted by the risk that a coin or bar might not be as valuable as its owner said it was.
This authentication problem could be solved by everyone instead using coins produced by a single, trusted issuer. The first coin to be widely accepted for international trade was the Aegina “turtle” coin, a silver coin minted on the island of Aegina, near Athens, that featured a turtle stamp as a guarantee of the weight of silver in the coin.1 However, after Athens seized Aegina in 450 BCE, the Athenian “owl” or tetradrachm gradually replaced the turtle as the common currency for international trade.2
The tetradrachm was a thick, heavy silver coin that featured an image of Athena, goddess of wisdom, on one side and an owl, her symbol, on the other. As the power and influence of Athens increased, the “owl” became ubiquitous throughout the Mediterranean region.3 However, once Rome displaced Athens as the dominant regional power, Roman coinage, particularly the silver denarius,4 replaced the owl.
After the fall of the Roman Empire in the 5th century, the gold solidus or “bezant,” issued by the Byzantium empire, became the closest equivalent to an international trade currency.5
In the 13th century, a new Mediterranean power emerged: the Republic of Florence. From 1252 to 1533, Florence minted a gold coin known as the “fiorino d’oro,” or “florin,” which had a fixed gold content of 72 grains (3.52 grams).6 It quickly became the standard currency for international trade in Europe.
Other cities and principalities across Europe followed suit, minting their own gold coins. To this day, the memory of the florin and its imitators lives on—for example, in the name of Hungary’s currency, the forint. However, as the quantities of gold in these imitation coins varied, the Florentine coin became the benchmark against which the international value of the other coins was measured. Thus was born an early form of the foreign exchange market.
Not only was the minting of the Florentine florin the genesis of the foreign exchange market, but it also underpinned innovations in international trade finance. The fact that the florin was gold-based made it a target for thieves; even though the coins were issued in sealed leather bags, merchants carrying them were at risk of highway robbery. So Florentine banks devised a way of enabling merchants to pay for purchases without having to carry large quantities of gold coins: They issued loan notes that merchants could present to their counterparties in foreign cities in place of locally issued coins. The counterparty could then claim locally issued coins from the merchant’s local agent bank at the exchange rate defined in the note. Those notes were—and still are—known as “bills of exchange,” since they in effect let merchants trade in foreign currencies without having to obtain the coins.
This structure not only reduced the risk to merchants of carrying coins, but it also eased cash flow difficulties, since merchants could repay the loan notes in their own currency (with interest) after selling the goods purchased—an early form of trade credit. Oftentimes, a bill of exchange (“cambium”) would be repaid by taking out another bill of exchange in the opposite direction (“recambium”), thus eliminating physical settlement of the bills in coins.7
After it was devalued in the early 15th century, the Florentine florin’s dominance in international trade gradually declined, giving way to the Venetian ducat.8
In the 16th century, inflows of gold from the Americas enabled the Spanish dollar to replace the Venetian ducat as the dominant currency for international trade. But a new European power, the Netherlands, was already emerging. In the 17th century, the Dutch florin or “guilder” (meaning “golden”) became the dominant trade currency. It remained so until the latter part of the 18th century. But by this time, the guilder no longer was made of gold. It was simply an accounting entry on the books of the Bank of Amsterdam, what we now know as a “fiat” currency. As its value declined, traders turned to another currency: the British pound.9
Britain’s currency had been on a de facto gold standard since 1717, when Sir Isaac Newton, the Master of the Royal Mint, fixed the value of the country’s silver coins in relation to the gold guinea. That value proved to be too high, and silver gradually went out of use. In 1816, Britain formally adopted gold as the basis for its currency.
Simultaneously, Britain was amassing an empire that at its height encompassed a quarter of the globe's land area. Because of the U.K.’s global dominance, the pound became the premier currency for international trade. The British gold sovereign circulated freely worldwide; pound bank notes also circulated, but they were fully backed by gold reserves. Some countries minted their own gold coins, which were exchangeable for gold sovereigns at an exchange rate that depended on their gold content. Unlike the modern FX market, therefore, the one based on the international gold standard was a system of fixed exchange rates. The only way to devalue a currency was to reduce its gold weight.
Having a system of fixed exchange rates backed by gold facilitated international trade. Many now regard the late 18th century as a “golden age” of trade.10 But it proved fragile. As a result, the international gold standard was suspended at the start of World War I, in 1914. An attempt to restore it starting in the 1920s failed when country after country abandoned the link to gold at the height of the 1930s Great Depression.11
After World War II, there was another attempt to create an international trade currency system backed by gold, in the form of the Bretton Woods system of managed exchange rates, agreed to by the U.S., Canada, Western Europe, Australia, and Japan. By this time, the U.S. dollar had superseded the pound as the gold-linked international currency to which all other currencies were bound. But the Bretton Woods system ended in 1971, when President Nixon, fearing loss of the U.S.’s gold reserves because of the country’s persistent trade deficit, suspended the convertibility of the U.S. dollar to gold.
Ending the U.S. dollar’s link to gold heralded an unprecedented expansion of international trade, particularly after the dissolution of the U.S.S.R. in 1992 ended the rouble’s dominance in Eastern Europe.12 The U.S. dollar is now the “gold standard” currency for international trade—but there is no gold involved. Instead, global trade depends on the promise that the U.S. government makes on every dollar bill: that “this note is legal tender for all debts, public and private.”
Of course, international trade does not take place only in U.S. dollars. But the U.S. dollar is the benchmark against which the value of all other currencies is measured. In April 2016, 88 percent of foreign exchange transactions involved the U.S. dollar, according to the Bank for International Settlements.13 And because gold is no longer involved, the value of other currencies relative to the dollar depends on economic conditions and market sentiment, which can vary from day to day, even minute to minute.
Today, as throughout history, the preferred currency for international trade is the currency of the world’s largest economy. However, unlike the dominant trade currencies of the past, the U.S. dollar of today is not backed by any precious metal. Rather, it is backed by the “full faith and credit” of the government of the richest country on earth. Trade takes place in many currencies, but all currencies ultimately are valued by reference to the U.S. dollar, against which many of them freely float. Markets, not gold weights, determine the relative values of those currencies. Thus, today’s foreign exchange rates are necessarily volatile, but today’s businesses have the tools and technology to manage FX risks effectively.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “Aegina Turtle,” Greta Parker; https://www.gretaparker.com/pages/aegina-turtle.html
3. “Ancient Coins—The Most Famous Coin of Antiquity—the Athenian Owl,” CoinWeek; https://coinweek.com/ancient-coins/ancient-coins-famous-coin-antiquity/
4. “Roman coinage,” Ancient History Encyclopedia; https://www.ancient.eu/Roman_Coinage/
5. “Life in the Middle Ages: Trade in the Dark Ages,” C. Dale Brittain; http://cdalebrittain.blogspot.com/2017/03/trade-in-dark-ages.html
6. “The Florentine florin,” Encyclopedia of Money; http://encyclopedia-of-money.blogspot.com/2010/02/florentine-florin.html
7. “The Bill of Exchange, Draft, or Acceptance Bill,” University of Toronto; https://www.economics.utoronto.ca/munro5/BILLEXCH.htm
8. “The Florentine florin,” Encyclopedia of Money; http://encyclopedia-of-money.blogspot.com/2010/02/florentine-florin.html
9. “Death of a reserve currency,” Federal Reserve Bank of Atlanta; https://www.frbatlanta.org/-/media/documents/research/publications/wp/2014/wp1417.pdf
10. “Tariff Policy—Golden Age of Trade,” Encyclopedia of the New American Nation; http://www.americanforeignrelations.com/O-W/Tariff-Policy-Golden-age-of-trade.html
11. “Golden Fetters,” Eichengreen https://www.amazon.co.uk/Golden-Fetters-Depression-1919-1939-Development/dp/0195101138
12. “Is today’s globalization different from what has gone before?” Martin Wolf; http://faculty.chicagobooth.edu/marvin.zonis/teaching/33511/wolfglobalisation.doc
13. “Triennial Central Bank SurveyForeign Exchange Turnover in 2016,” Bank for International Settlements; https://www.bis.org/publ/rpfx16fx.pdf