What is Adjustment
Adjustment is the use of mechanisms by a central bank to influence a home currency's exchange rate. An adjustment is specifically made if the exchange rate is not pegged to another currency, meaning that the currency is valued according to a floating exchange rate. Because the central bank intervenes in the home currency's exchange rate to reduce short-term fluctuations, this is considered a managed floating exchange rate.
BREAKING DOWN Adjustment
Central banks may become involved in adjustment if they believe that movements in the home currency are too "extreme", especially since a rapid increase or decrease in a currency's value can lead to a significant effects on its economy. Inconsistent adjustment policies in terms of an exchange rate mechanism (ERM) result in uncertainty on the part of investors, and is referred to as a "dirty" managed exchange rate policy.
Currency Adjustment Factor
Another application of adjustment happens in the shipping industry, where shippers charge the Currency Adjustment Factor surcharge to account for the volatility in currency exchange rates. The "CAF," as it may appear on a shipping invoice, varies according to the destination country. For example, if the "basic ocean freight" rate for a particular shipment to, say, Peru is $15,000 and the CAF rate for Peru is 6 percent, then the CAF for the shipment will be $900. The rates are designed to even out fluctuations in exchange rates. Sometimes, the CAF will provide more money than the shipper really needs, sometimes less.
For American shippers, the currency adjustment factor rises as the value of the U.S. dollar falls. It is applied as a percentage on top of the base exchange rate, which is calculated as the average exchange rate for the previous three months. Due to this added charge, shippers are now looking to enter into "all inclusive" contracts at one price, that accounts for all applicable charges, to limit the effect of the CAF.
Ocean freighters first started charging CAF when the exchange rates between the United States and the Pacific Rim countries started to become too volatile for the steamship lines and freight carriers to keep pace with and keep policies current. As a result, they were losing excessive money on the exchange rates, so they came up with an additional percentage that would even out the losses – the CAF. This CAF percentage has now become even more important to steamship lines because of the many ups and downs in currencies around the world.