The Current Forex System: Floating Exchange Rates

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After the end of the Bretton Woods system, there was a need for a new foreign exchange system to be adopted in order to enable international exchange of currencies. The Jamaica agreement of 1976 officially ratified a floating exchange rate. This permanently abolished the gold standard, thus allowing the rate of exchange between various currencies to float irrespective of any other type of physical asset.

Three Currency Exchange Rate Systems

After the Jamaica agreement governments still did not adopt purely free-floating currency exchange rate policies. Most governments have adopted one out of three commonly used currency exchange rate systems. These systems are: dollarization, pegged rate exchange systems and managed floating rate exchange systems.

Dollarization

Some countries, instead of issuing their own currency, decide to use the U.S. dollar as the official currency accepted within their economy. This policy allows a country to be viewed more stable and attractive for investment opportunities. However, this also means the country will not be able to create its own currency in order to implement monetary policy aims.

Pegged Currency Rates

Another option countries have commonly adopted is pegged currency rates. This happens when a country fixes its currency exchange rate directly to a foreign currency. Pegging a currency allows for more stability than purely free-floating forex rate. This keeps the currency’s exchange rate fixed with another particular currency. Some countries even use a basket of specific currencies in order to peg their own currencies. Pegging a currency ensures that its value will not fluctuate unless the pegged currency value(s) change.

Managed Floating Currency Rates

Many governments have decided to adopt a managed floating currency rate system. This enables a currency’s value to change with supply and demand in the free market. However, this system also enables a government or central bank to intervene in the currency’s exchange rates in order to calm extreme currency market fluctuations. Central banks utilize a variety of monetary tools to manage currency rates and intervene in the forex market.

Understanding the currency systems most commonly used by governments around the world will help investors and traders analyze how monetary policy decisions affect forex market fluctuations. However, monetary policy is only one factor affecting supply and demand dynamics in the currency exchange markets. Other factors will include, the health of a country’s economy, commodity prices, political events and even social turmoil.

 

Writer Bio

LeBach PhamLe Bach Pham has been writing professionally after receiving his Bachelor’s of Art in English Literature from the University of California, San Diego in 2002. He now specializes in writing about legal, business and financial topics. Pham also earned a Paralegal Certificate from the University of San Diego and has experience working in the legal field. He also has experience in writing business plans for clients from various fields, including banking, finance, retail, education, beauty and various other sectors.
Sources:

  • http://www.investopedia.com/university/forexmarket/forex4.asp
  • http://financial-dictionary.thefreedictionary.com/Jamaica+Agreement
  • http://financial-dictionary.thefreedictionary.com/Managed+Float

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