Forex: The Development of Exchange Controls

By 1914 and the outbreak of World War I, the world's foreign exchange system was quite developed and formed an efficient system of payment for international economic transactions.

In general, as a result of the expansion in international commerce, the twentieth century witnessed substantial growth in all phases of foreign exchange, despite a number of governmental restrictions. More and more foreign exchange business was transacted by the use of telephone, Telex, and telegraph. Instead of formal meeting places where traders gathered to transact business, foreign exchange markets became a multinational structure linked by communication networks.

A number of restrictions on free foreign exchange dealings were inaugurated by many countries during the years of World War I, as well as in those immediately following. Governments began to fear the effect on their economies, or the war effort, of letting capital and reserves move freely among the industrial countries.

As the war progressed, intervention in the foreign exchange markets was practiced by many of the belligerents and some of the neutrals, and various systems of exchange controls were adopted. The gold standard was abandoned by several European countries shortly after the outbreak of the war, only to be readopted later by some nations and finally abandoned by all, including the United States during the Great Depression.

In a country where the gold standard was abandoned, some form of the gold exchange standard was usually installed in its place. Under that standard, paper money is employed as the domestic currency and the country maintains a reserve of gold and convertible foreign exchange (convertible to gold), other currencies, or both) so it can protect its rates of exchange, continue to trade during periods of balance of payments deficits, and instill confidence in its currency.

Under the gold exchange standard, foreign exchange transactions are carried out by means of various forms of credit instruments and gold is only rarely employed for that purpose.

After 1918, the currencies of some European countries depreciated rapidly because of rampant monetary inflation, and sometimes little attempt were made to support their rates of exchange. With the advent of the Great Depression and its devastating effects upon the national economies, governments appeared to be at their wit's end to discover and apply remedies. Country after country devalued its currency.

The devaluing countries hoped that lower exchange rates would increase their exports by making their goods cheaper abroad and simultaneously check imports by increasing the prices of imported goods. Between 1933 and 1934, the United States devalued the dollar by raising the price of gold from $20.67 to $35.00 per fine troy ounce, a reduction of 59.06 percent.

However, the competitive devaluations did not have the anticipated results, because the devaluation of one currency was frequently countered by that of another.

In World War II, as in World War I, most of the belligerents and many of the neutrals adopted stringent exchange controls in an effort to associate declining international reserves. The declines in reserves resulted from a dire need for imports and an inability to export in sufficiently large amounts to balance imports.

The exchange controls were continued in the years immediately following the war and remained in effect during the postwar years until the late 1950s and early 1960s. In addition, the governments of a large number of countries intervened frequently and often massively on the foreign exchange markets in an effort to protect their exchange rates.