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 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. Investing

    The Pros And Cons Of A Pegged Exchange Rate

    A pegged exchange rate occurs when one country fixes its currency’s value to the value of another country’s currency. But it has both pros and cons.
  2. Investing

    Explaining Fixed Exchange Rates

    A government using a fixed exchange rate has linked the value of its currency to the value of another country’s currency, or the price of gold.
  3. Trading

    Top Exchange Rates Pegged To The U.S. Dollar

    From the end of World War II until around 1971, all countries in the IMF pegged their currencies to the U.S. dollar. Today, many still do.
  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

    Dual And Multiple Exchange Rates 101

    Why would a country choose to implement dual or multiple exchange rates? It's risky, but it can work.
  7. Trading

    How Undervalued Is The Yuan?

    Some argue that the large U.S. trade deficits over the past 15 years are primarily due to currency management by U.S. trading partners.
  8. Trading

    The Effects Of Currency Fluctuations On The Economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate of one currency versus the other is influenced by ...
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center