What is a 'Dirty Float'

A dirty float is an exchange rate regime in which the country's central bank occasionally intervenes to change the direction or the pace of change of the country's currency value. In most instances, the intervention aspect of a dirty float system is meant to act as a buffer against an external economic shock before its effects become truly disruptive to the domestic economy. It's also known as a "managed float."!--break--From 1946 until 1971, many of the world's major industrialized nations participated in a fixed exchange rate system known as the Bretton Woods Agreement. This ended when President Richard Nixon took the United States off the gold standard on Aug. 15, 1971; since then, most major industrialized economies feature floating exchange rates.

Many developing nations seek to protect their domestic industries and trade by using a managed float in which the central bank intervenes to guide the currency. The frequency of such intervention varies. For example, the Reserve Bank of India manages the rupee closely in a very narrow band, while the Monetary Authority of Singapore allows the local dollar to fluctuate more freely in an undisclosed band.

There are several reasons why a central bank intervenes in a currency market that is usually allowed to float.

Market Uncertainty

Central banks with a dirty float sometimes intervene to steady the market at times of widespread economic uncertainty. The central banks of both Turkey and Indonesia intervened openly numerous times during 2014 and 2015 to combat currency weakness caused by instability in emerging markets worldwide. Some central banks prefer not to publicly acknowledge when they intervene in the currency markets; for example, Bank Negara Malaysia was widely rumored to have intervened to support the ringgit during the same period, but the central bank has not acknowledged it.

Speculative Attack

Central banks sometimes intervene to support a currency that is under attack by a hedge fund or other speculator. For example, a central bank may find that a hedge fund is speculating that its currency might depreciate substantially, thus the hedge fund is building up speculative short positions. The central bank can purchase a large amount of its own currency in order to limit the amount of devaluation caused by the hedge fund.

A dirty float system isn't considered to be a true floating exchange rate because, theoretically, true floating rate systems don't allow for intervention. However, the most famous show-down between a speculator and a central bank took place in September 1992, when George Soros forced the Bank of England to take the pound out of the European Exchange Rate Mechanism (ERM). The pound theoretically floats freely, but the BoE spent billions in an unsuccessful attempt to defend the currency.

BREAKING DOWN 'Dirty Float'

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