Floating exchange rate
Floating Exchange rate definition
A floating exchange rate moves freely based on global demand and supply. The factors affecting a currency are the country’s economic and financial performance. On the contrary, fixed exchange rates are controlled by the country’s central bank and are fixed to another currency, a basket of currencies or a commodity like gold.
Most of the world’s currencies have floating exchanges rates. These currencies are not backed by anything except from a government law declaring it to be the accepted medium of exchange in the country. This is called a fiat money system where the value of the currency is dependent on the market’s faith and confidence in its purchasing power. This is determined by the supply and demand for the currency in relation to the goods and services.
In a fiat money system, the government and more specifically the central bank, determines the supply of money. Central banks have no limits in the money supply which often leads to financial crisis.
Factors affecting Floating Exchange Rates
There are a lot of variables that can affect a floating exchange rate strength. Current account balances are the foundation for currency strength over the long run. In the short-term currencies are affected by interest rates differentials and supply/demand imbalances. Learn more about how trade currencies using our free guide on forex trading.
Floating exchange rates have certain advantages when compared to fixed exchange rates. The advantages of floating exchange rates are presented below:
Automatic Trade Balance Adjustment
A high exchange rates causes a reduction in exports since the exported goods are more “expensive” relative to the same goods produced in other countries. Hence, the demand for the country’s currency falls since less goods are exported. At the same time, imported goods are “cheaper” than the same goods produced domestically. The domestic currency is sold to purchase foreign goods imported.
The currency’s market forces cause the country’s balance of payments (BOP) to self-adjust. Under a floating exchange rate regime, policymakers don’t have to spend resources monitoring the exchange rate. Instead, they focus on maximizing the country’s potential that is boost economic growth while maintaining inflation stable.
One of the main disadvantages of floating exchanges rates is the inability of the country’s exporters and importers to manage their businesses since their revenues, investment costs and variable costs fluctuate according to the country’s exchange rate.
When countries’ central banks or government intervene in foreign exchange markets to manipulate their currency by buying and selling foreign assets, this is referred to as managed float or dirty float.
Floating Exchange Rates analysis
- US Dollar: The US dollar (DXY) is an independent free floating currency but the Fderal Reserve affects the currency’s strength through Quantitative Easing to suit its macroeconomic objectives
- Euro: The Euro (EUR) is is an independent free floating currency but the ECB affects the currency’s strength through Quantitative Easing to suit its macroeconomic objectives
- Japanese Yen: The Japanese Yen (JPY) is is an independent free floating currency but the BoJ affects the currency’s strength through Quantitative Easing to suit its macroeconomic objectives
- British Pound: The British Pound (GBP) is is an independent free floating currency but the BoE affects the currency’s strength through Quantitative Easing to suit its macroeconomic objectives
- Swiss Franc: The Swiss Franc (CHF) used to have a crawling peg against the Euro. Currently it is considered as free floating currency.
- Swedish Krona: The Swedish Krona (SEK) is managed float since 1992
- Czech Koruna: The CZK is free floating since 1992. The Czech Republic was supposed to join Euro in 2012but strong internal opposition delayed the conversion.
- Hungarian Forint: The HUF is free floating since 2001. Hungary has suspended joining the Euro till 2020.
- Polish Zloty: the PLN is free floating currency since 2000
- Israeli Shekel: The ILS is a free floating currency since 2003.
- Romanian Leu: RON is a managed float since 2005
- Ukranian Hrycnia: UAH is a manged float since 2005
- Korean Won: KRW is a manged float
- Phillipine Peso: PHP is a managed float
- New Taiwan Dollar: TWD is a managed float.
- Thai Baht: BHT is independent free floating currency since 1984
- Vietnamese Dong: VND is a managed float currency.
- Australian Dollar: AUD is free floating currency since 1983 moving from a managed float status
- New Zealand: The NZD is free floating currency since 1985. It previously was crawling PEG during 1979-1982 and a managed float against a trade weighted index between 1982 and 1985.
- Canadian Dollar: The CAD is free floating currency since 1998. Previously it was a managed float since 1970.
- Norwegian Kroner: the NOK is free floating currency since 1992. Previously, it was fixed to GBP and USD.
- Egyptian Pound: The EGP is a free floating currency since 2003. It was previously pegged to USD until 1989 and a managed float till 2003.
- Icelanding Krona: The ISK is managed float since 2001. During the 2008 financial crisis the 3 largest Icelandic banks became insolvent causing a significant devaluation.
- Russian Rouble: The RUB is managed float since 1999. The Rouble is highly managed and the currency policy has changed multiple times in the past.
- South African Rand: The ZAR is an independent free floating currency since 1979
- Turkish Lira: The TRY is free floating currency since 1992.
- Indian Rupee: The INR is a free floating currency officially. However, in reality the INR is a managed float. India’s central bank (RBI) trades actively the USD/INR to control INR volatility.
- Indonesian Rupiah: The IDR is an independent free floating currency. The IDR lost 80% of it’s value during the 1997 Asian Financial crisis.
- Kazakhstan Tenge: The KZT is a managed float currency. It replaced the Russian Rouble in 1993.
- Malaysian Ringgit: The MYR is a managed float currency against several major currencies.
- Argentine Peso: The ARS is a free managed float currency with tight government controls.
- Brazilian Real: The BRL is an independent free floating currency since 1999 after a 90% devaluation in 1998-1999 financial crisis.
- Chilean Peso: The CLP is an independent free floating currency since 1999.
- Colombian Peso: The COP is an independent free floating currency since 1999.
- Mexican Peso: The MXN is an independent free floating currency since 1994.
- Peruvian New Sol: The PEN is an indepent free floating currency since 1990.