From trading grain, cattle to beads – money has gone a long way since the early days of commodity money.
Fast-forward to today and now every country has its own standardised tender. Add to the mix a global economy, and the foreign exchange (forex) market is born. How much a currency is worth is relative to another currency. But how exactly is this exchange rate determined?
It was only a few decades ago that currencies around the world were back by gold. This meant that whatever piece of money that people used in their day-to-day lives represented a real amount of gold held by that government.
Today, things are a bit different. In our latest infographic and animated video we take a look at some of the main influencing factors on exchange rates.
Since the Jamaica Accord of 1976, which ratified the end of the Bretton Woods System, the gold standard system has became permanently abandoned and the world now adopts a floating foreign exchange rate. But though the name might suggest exchange rates are left to their own devices – today, most governments use one of the following methods: Managed floating rate The exchange rate is allowed to float in the foreign exchange market, with supply and demand determining the value of a given currency. However, it is ‘managed’ – the central bank will set the range its currency is allowed to freely float between, and intervene when necessary to manipulate the value by buying and selling currencies. The benefit of this is that governments can minimise any risks of extreme currency fluctuation, which is highly possible in a free-floating system. Pegged rate A country fixes its exchange rate to that of another country’s currency. To keep the rate stable, the country that is pegging its currency must keep large reserves of the foreign currency on hand to mitigate any potential shifts in supply or demand. Countries with unstable economies usually use a pegged rate system. The downfall of this system is that the market value of a currency isn’t always truly reflected in the pegged rate – thus possibly encouraging a black market. Dollarization Dollarization, or currency substitution, is when citizens of a country either officially or unofficially use another country’s currency as legal tender. The benefit is often that the foreign currency is more stable than the domestic currency. Examples of countries who use dollarization include El Salvador, Ecuador and Panama, who officially use US dollars. Other examples include Namibia, Swaziland and Zimbabwe who all use the South African rand alongside the Namibian dollar, Swazi Lilangeni and US dollar/Euro/Botswana pula respectively So know you know the systems in place – but what does this all mean for you? You may have crossed an international border recently and have had to exchange your money from your local currency to another. Or you might have purchased goods online from a shop based overseas. Or you might be trading in the foreign exchange market. Chances are, you’ve dealt with exchange rates before. In fact, if you’ve done any of the above, you’re a small factor in influencing exchange rates.
M Samer Al Reifae
Official Representative in Romania at HiWayFX
http://lordoftruth.blogspot.com
samer@hiwayfxglobal.com
+40 734 277 757
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I intend to portray my thoughts and ideas on the subject which may s be used as a tool for the reader.
I do not accept responsibility for being incorrect in my speculations on market trend.
I intend to portray my thoughts and ideas on the subject which may s be used as a tool for the reader.
I do not accept responsibility for being incorrect in my speculations on market trend.
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