Current Exchange Rates
After the Bretton Woods system broke down, the world finally adopted the use of floating foreign exchange rates during the Jamaica agreement of 1976. This meant that the use of the gold standard would be permanently abandoned. However, that doesn't mean that governments adopted a purely free-floating exchange rate system. Most governments today use one of the following three exchange rate systems:

  • Dollarization
  • Pegged rate
  • Managed floating rate

Dollarization
Dollarization occurs when a country decides not to issue its own currency and uses a foreign currency as its national currency. Although dollarization usually allows a country to be seen as a more stable place for investment, the downside is that the country's central bank can no longer print money or control the country's monetary policy. One example of dollarization is El Salvador's use of the U.S. dollar. (To read more, see Dollarization Explained.)

Pegged Rates
Pegging is when one country directly fixes its exchange rate to a foreign currency so that the country will have somewhat more stability than a normal float. More specifically, pegging allows a country's currency to be exchanged at a fixed rate. The currency will only fluctuate when the pegged currencies change.

For example, China pegged its yuan to the U.S. dollar at a rate of 8.28 yuan to US$1, between 1997 and July 21, 2005. The downside to pegging is that a currency's value is at the mercy of the pegged currency's economic situation. For example, if the U.S. dollar appreciates substantially against all other currencies, the Chinese yuan will also appreciate, which may not be what the Chinese central bank wants, since China relies heavily on its low-cost exports.

Managed Floating Rates
This type of system is created when a currency's exchange rate is allowed to freely fluctuate subject to supply and demand. However, the government or central bank may intervene to stabilize extreme fluctuations in exchange rates. For example, if a country's currency is depreciating very quickly, the government may raise short-term interest rates. Raising rates should cause the currency to appreciate slightly; but understand that this is a very simplified example. Central banks can typically employ a number of tools to manage currency.



Market Participants

Related Articles
  1. Trading

    Currency Exchange: Floating Rate Vs. Fixed Rate

    Baffled by exchange rates? Wonder why some currencies fluctuate while others are pegged? This article has the answers.
  2. Trading

    Understanding the Floating Exchange Rate

    Floating exchange rate is the exchange rate between two currencies at any given time.
  3. Investing

    Why Countries Keep Reserve Currency

    Central banks and financial institutions hold large amounts of foreign money as their reserve currency.
  4. Insights

    How Does a Currency Peg Work?

    When a government initiates a currency peg, it pegs its currency’s value to that of another country.
  5. Trading

    Dollarization Explained

    Find out how fledgling economies can find some stability in their currency and attract foreign investment.
  6. Trading

    6 Factors That Influence Exchange Rates

    An in depth look at out how a currency's relative value reflects a country's economic health and impacts your investment returns.
  7. Insights

    The US Will Remain the World's Reserve Currency

    Learn why the U.S. dollar is not in any danger of losing its reserve currency status and understand how China is pushing the yuan to be a reserve currency.
  8. Trading

    How Inflation-Fighting Techniques Affect The Currency Market

    Central banks use these strategies to calm inflation, but they can also provide longer-term clues for forex traders.
  9. Trading

    Here's How You Calculate An Exchange Rate

    Struggling to get a grasp on exchange rates? Here's what you need to know.
Frequently Asked Questions
  1. What are the Differences Between Ex Works (EXW) and Free On Board (FOB)?

    Learn about Ex Works and Free on Board, the main difference between these Incoterms, and the responsibilities of buyers and ...
  2. What are Common Examples of Monopolistic Markets?

    Discover what causes real instances of market monopoly, how it persists and where monopoly privilege is most common in the ...
  3. What is the gold standard?

    The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold, but ...
  4. What's the most expensive stock of all time?

    The most expensive publicly traded stock of all time is Warren Buffett’s Berkshire Hathaway.
Trading Center