Currency exchange can be well understood when you understand the history first. For hundreds of years, gold has backed up the numerous currencies of the world. This means that paper currency has been represented by an actual gold amount kept by the government that issued it in a secure location.
In the 1930s, the United States appraised the US dollar at an unchanging level, wherein every $35 US dollar is corresponding to one ounce of gold. Accordingly, any other kind of currency is valued easier against the dollar for its value can be based on gold. Therefore, a currency that is worth three times as much gold as the US dollar was worth three times as much as the US dollar. However, this didn’t last very long because, in time, the real world economics moved quicker that this system could keep up.
These days, the US dollar is still considered atop most financial markets, but the difference is that it is no longer represented by an actual amount of gold or any other precious substance for that matter. The market now directs the US dollar and there are two main systems that regulate the exchange rates, namely the floating currency system and the pegged currency system. Here is a brief discussion of the two systems that you need to consider.
The market determines the rates in a floating exchange system, which basically means that the value of the currency is equivalent to what the market is willing to pay. This is regarded simple supply and demand, which think of factors such as inflation, import and export ratios, and several other things related to economy. This system is commonly used by major nations in the world because of having much more stable economic markets. Floating exchanges rates are more widely used as well since they are considered to be the most efficient. They depend more on the market to adjust the rates as they deal with inflation and other economic changes.
As a fixed rate system, the pegged system is maintained by the government thus, it doesn’t fluctuate because it is pegged directly to some other countries currency, typically the US dollar. This form of system is often used where economies have the change of becoming unstable or immature, specifically in developing countries as they give an effort to protect themselves against wildly out of control inflation. This can easily backfire since black markets could tend to spring up to exchange currency at its market value, hence, ignoring the rate set by the government.
Some people might realize that their currency is worth as much as what they government says so they have a tendency to flood the market and exchange their currency with others. Consequently, the money exchange rate is propelled to become dangerously low and the currency of a particular country becomes insignificant.
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