Every country came out with their own banknotes or currencies. They were given different names such as Dinar, Franc, Lira, Krone, Mark, Peso, Pound, Rial, Ruble, and Rupee. Some gave the same name but of different value such as dollar for the United States, Canada, Australia, Malaysia, Singapore and Zimbabwe. Some countries adopted a common currency as Euro by the European Union. The trade between countries was to be transacted with their respective currencies. This required that exchange rates between currencies are to be fixed. These were fixed by the central bank and the government. Banks and governments have to sell and buy currencies in order to facilitate international trade.
With increased exports, the demand for the currency of the exporting country rose up. This fueled an increase in its value and exchange rate. Currency now has a floating rate where its exchange rate with respect to another currency is determined more by the demand and supply in the forex market where currency is traded as a commodity. Intermediaries to trade in currency for investors soon emerged such as currency traders and money managers. The lion’s share of the currency traded is now speculative rather than for transaction. Speculation in currency has become an influencing factor in determining the exchange rate.
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By the 13th century itself, paper money emerged with China as the first country to adopt paper money. In 1661 Sweden too shifted over to paper money and was the first European country to do so. Sweden’s copper based money system was too difficult to handle when the goods to be traded was of higher value. Paper money soon spread as it was easy to produce, take anywhere and transact. Moreover, the respective governments too backed it up by linking the currency to gold standard till about 1990. But this was soon abandoned. Now it has a floating rate with the market itself determining its rate.