Forex Walkthrough

AAA

Level 2 Markets - History Of Exchange Rates

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. Professionals

    Fixed vs. Pegged Exchange Rate Systems

    CFA Level 1 - Fixed vs. Pegged Exchange Rate Systems. Discusses the rise and fall of the gold standard. Learn how the pegged exchange rate system combines both fixed and floating exchange rates.
  2. Forex Education

    Forex Tutorial: Forex History and Market Participants

    Given the global nature of the forex exchange market, it is important to first examine and learn some of the important historical events relating to currencies and currency exchange before entering ...
  3. Forex Fundamentals

    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.
  4. Investing Basics

    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.
  5. Forex Fundamentals

    Understanding the Floating Exchange Rate

    Floating exchange rate is the exchange rate between two currencies at any given time.
  6. Forex

    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.
  7. Term

    Why Countries Keep Reserve Currency

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

    Macroeconomics: Currency

    By Stephen Simpson For citizens of different countries to conduct trade, they have to buy and sell each other's currencies. The price of a nation's currency, expressed as an amount of a second ...
  9. Term

    How Does a Currency Peg Work?

    When a government initiates a currency peg, it pegs its currency’s value to that of another country.
  10. Forex Education

    Dollarization Explained

    Find out how fledgling economies can find some stability in their currency and attract foreign investment.
RELATED TERMS
  1. Currency Peg

    A country or government's exchange-rate policy of pegging the ...
  2. International Currency Exchange ...

    The rate at which two currencies in the market can be exchanged. ...
  3. Adjustable Peg

    An exchange rate policy adopted by some countries wherein the ...
  4. Currency Board

    A monetary authority that makes decisions about the valuation ...
  5. Adjustment

    The use of mechanisms by a central bank to influence a home currency's ...
  6. Fixed Exchange Rate

    A country's exchange rate regime under which the government or ...
RELATED FAQS
  1. How are international exchange rates set?

    International currency exchange rates display how much one unit of a currency can be exchanged for another currency. Currency ... Read Answer >>
  2. What is foreign exchange?

    Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free economy, a country's ... Read Answer >>
  3. How does inflation affect the exchange rate between two nations?

    Understand how inflation can affect foreign exchange rates of a currency and how it is just one of many economic factors ... Read Answer >>
  4. How do changes in national interest rates affect a currency's value and exchange ...

    Understand the role that changes in interest rates can play in determining the value and foreign exchange rate of a country's ... Read Answer >>
  5. What types of companies benefit from reporting results utilizing constant currencies ...

    Understand constant currency figures, and explore some of the reasons why a company is likely to benefit from reporting using ... Read Answer >>
  6. How does the balance of payments impact currency exchange rates?

    Take a brief look at the relationship between a nation's balance of payments and the exchange rate value of its currency ... Read Answer >>

You May Also Like

Hot Definitions
  1. Goodwill

    An account that can be found in the assets portion of a company's balance sheet. Goodwill can often arise when one company ...
  2. Return On Invested Capital - ROIC

    A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ...
  3. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  4. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  5. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  6. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
Trading Center