Currency exchange can be understood well if you understand first the history. For hundreds of years, gold has backed up the numerous currencies of the world. This signifies that paper currency has been represented by an actual gold amount kept by the government that issued it in a safe location.
In the 1930s, the United States rated the US dollar at an unchanging level, wherein every $35 US dollar is equal 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. 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 since, ultimately, 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 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 usually used by major nations in the world as a result 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 so, it doesn’t fluctuate because it is pegged directly to some other countries currency, usually the US dollar. This kind of system is often used where economies have the possibility of becoming unstable or immature, particularly in developing countries as they give an effort to protect themselves against wildly out of control inflation. This can easily backfire because black markets may tend to spring up to exchange currency at its market value, thus, ignoring the rate set by the government.
Some people may recognize that their currency is worth as much as what they government says so they are likely 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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