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. 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

    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 ...
  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.
  10. Trading

    Main Factors that Influence Exchange Rates

    The exchange rate is one of the most important determinants of a country's relative level of economic health and can impact your returns.
Frequently Asked Questions
  1. Where else can I save for retirement after I max out my Roth IRA?

    The first option to explore is to determine if you can contribute to a 401(k), 403(b), or 457 plan at work. If your employer ...
  2. How did George Soros "break the Bank of England"?

    In Britain, Black Wednesday (September 16, 1992) is known as the day that speculators broke the pound. They didn't actually ...
  3. What counts as "debts" and "income" when calculating my debt-to-income (DTI) ratio?

    It's important to know your debt-to-income ratio because it's the figure lenders use to measure your ability to repay the ...
  4. Who are Monsanto's main competitors?

    Learn about Monsanto Company's two main operating divisions and its main competitors within each sector, including The Mosaic ...
Trading Center