With the flourishing of human civilization in different parts of the world, none would have realized that they would eventually be trading in paper currency in the later ages. The primary mode of trade and commerce was the barter system. A barter system was one where one would exchange their own goods or services in return for their desired goods/ services. However, slowly and gradually, its shortcomings started to magnify and afflict the economic activities at large. For example, a person producing wheat might approach a poultry farmer to exchange his wheat production for dozens of eggs. But, what if the poultry farmer already had plenty of wheat stock with him and demands 2 kg of apple in return. Obviously, now the wheat-producing farmer would have to search for some other poultry farm or an apple farm to procure some apple so as to eventually procure the eggs which he earlier needed.
Such events led to the introduction of coins and paper currency as the medium of exchange.
By the end of the 2nd world war, most of the countries around their world had their own currency. Gold at that had high economic importance. With the United States of America emerging as a world power, post the surrender of the Japanese forces during the concluding phase of World War II, the allied nations decided to standardize their currency against some commodity. Thus in this attempt, a United Nations Monetary Conference was held at the Bretton Woods, New Hampshire in 1944.
A new financial system known as the Fixed Reserve System was devised and the US Dollar was chosen as the world reserve currency instead of the gold. This agreement was known as the Bretton Woods System and also led to the creation of the International Monetary Fund and the World Bank.
Under this new Fixed Reserve System, all the global currencies were fixed to the US$, while the US$ was tied to the Gold at $35 per ounce of gold at that very particular time. This meant, that a nation for example Australia would deposit its gold with the USA. The USA will in turn print an equivalent amount of currency in US$ and the same could be procured by Australia in return for its gold. US$ became a global currency for all international trade and commerce activities.
This eventually led to the printing of more US$ currency and there was a race amongst nations to fill their treasury with as much foreign reserve as possible. However, gradually the US started spending more on several other programs to start establishing its global supremacy. Several Research & Development programs in agriculture, defense, space programs, science, and technology were being undertaken and a huge amount of money was being spent on wars as well. This led to a slow discontent amongst other nations and they started exchanging their US$ reserve for gold which was held with the USA. With the increased supply of the US currency in the American market, the US started grappling with the problems of inflation and unemployment.
To safeguard the US economy, then US President Richard M. Nixon devalued the U.S. dollar relative to gold. In order to safeguard the US currency, he temporarily banned the convertibility of Gold on the 15th Of August, 1971, and pulled out of the Fixed Reserve System. By 1973, gold was no longer the commodity against which currencies will be printed and circulated.
Currently, all the nations across the world have their own independent currency printing mechanism which is again highly dependent on the US dollar as it is a global currency. US Dollar is still used as an exchange currency for all international activities.
In our next post, we will be understanding the reasons behind the devaluation of the Indian Rupee against the US $ and the slow fallout of the gradually strengthening Indian economy in the light of currency printing.