Currency exchange can be well understood when you understand the history first. For hundreds of years, gold has backed up the various currencies of the world. This indicates that paper currency has been represented by an actual gold amount kept by the government that issued it in a protected location.
In the 1930s, the United States valued the US dollar at an unchanging level, wherein every $35 US dollar is equivalent to one ounce of gold. Consequently, any other type of currency is valued easier against the dollar since its value can be based on gold. Hence, 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, eventually, the real world economics moved faster 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 controls the US dollar and there are two main systems that determine the exchange rates, namely the floating currency system and the pegged currency system. Here is a brief discussion of the two systems that you have to take into consideration.
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 deemed simple supply and demand, which considers 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 also more widely used because they are considered to be the most efficient. They count more on the market to fix the rates as they deal with inflation and other economic changes.
As a fixed rate system, the pegged system is maintained by the government hence, it doesn’t fluctuate because it is directly pegged to some other countries currency, usually 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 because black markets could tend to spring up to exchange currency at its market value, therefore, 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. As a result, the money exchange rate is driven to become dangerously low and the currency of a particular country becomes worthless.
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