The exchange rate refers to the relative value of the currencies of two states. In other words, this is the value of one currency, which is expressed in units of another.
Exchange Rate Setting Modes
It is worth familiarizing yourself with the existing exchange rate setting regimes:
• Based on gold parities. Currencies that are tied to gold, at a fixed rate correlate with each other. Previously, the gold standard was the regulator of the global auto-type market.
• Fixed rate. The central bank determines the exchange rate of the national currency. This mainly concerns the limits of free fluctuations in national currency rates, which is done in order to macroeconomic stabilization. For this, the Central Bank purchases or sells a specific amount of foreign currency.
• Floating exchange rate. It is determined as a result of unlimited fluctuations in supply and demand. In this case, the exchange rate will be the equilibrium price of the currency in the foreign exchange market. At the same time, fluctuations in the exchange rate, volumes of imports and exports, and the state of the balance of payments and trade are unlimited.
If the first two modes are understandable, then the floating exchange rate should be studied in more detail.
What is a flexible exchange rate?
A floating or flexible exchange rate is a mode in which exchange rates in the market can change depending on supply and demand. Under conditions of free oscillations, they can increase or decrease. It also depends on speculative operations in the market and the state of the balance of payments of the state.
Theoretically, the regime of freely floating exchange rates should be the reason for establishing an equilibrium exchange rate. In this case, the country will have sufficient capabilities to regulate the economic situation in the absence of external influence. However, in fact, flexible courses are causing destabilizing and erratic trends. The situation may be aggravated by the influx of speculative cash.
The conclusion of investment and trade agreements can become more difficult if partners are not sure of a profit. For this reason, it is preferable for countries to regulate exchange rates through intervention. But often enough, this develops into manipulating the exchange rate to gain a competitive advantage in trade with other states.
Creating a floating exchange rate system
In 1976, a meeting of the IMF interim committee was held, at which the Jamaican agreement was reached. This procedure consolidated the demonetization of gold and the transition to floating exchange rates. In the Russian Federation, the corresponding regime was established by decree of November 15, 1991. The system of floating exchange rates was formed under the influence of the ratio of supply and demand available on the foreign exchange markets of the state.
When conducting commercial operations in order to cover currency risk, urgent transactions began to be applied. This method has gained popularity since the end of the 60s. This time was marked by the transition to a floating regime, the crisis of the Bretton Woods system, as well as the instability of foreign exchange markets.
Reasons for creating a new system
Due to the instability of the foreign exchange markets in 1964, the convertibility of Japanese and other world currencies was announced. Thus, the United States lost the ability to maintain the price of an ounce of gold. The state has faced a rapid increase in inflation. Of course, the US government has taken a number of measures to combat this phenomenon, but they did not give a positive result.
US foreign debt is increasing annually, but the biggest dollar crisis was in 1970, which was explained by a decrease in interest rates. The following year, the balance of payments of the state experienced a severe deficit. The free conversion of dollars to gold has been suspended.
Much has been done to save the Bretton Woods system. An intervention of about $ 5 billion did not produce results. After the devaluation of the dollar by 10%, developed countries made the transition to a floating exchange rate.
Crisis management
Until 1973, it was possible to make good money on operations with monetary units. But there were problems in deriving speculative gains after fixed courses lost their relevance. At the same time, the regime of freely floating exchange rates entailed the bankruptcy of many large banks. At the same time, a large number of financial institutions were seriously affected. After the system was officially recognized, international financial relations began to succumb to regulation.
The transition to a floating exchange rate has eliminated most of the shortcomings and problems. Despite the advantages of this mode, they have some disadvantages. First of all, it is worth noting the high volatility of monetary units (the amplitude of fluctuations in value over a certain time). In most cases, this adversely affects international export-import operations.
The regime present in Russia
After the default that occurred in 1998 in the Russian Federation, the next year the regulated currency regime was launched. From that moment, the government was able to reduce the degree of negative impact of external conditions on the public sector of the economy. The floating exchange rate was complemented by the introduction of a dual-currency basket. It consisted of a combination of the euro and the dollar. Thanks to this action, it became possible to strengthen the management of the currency system.
After the introduction of the dual-currency basket, the ruble was oriented towards the two most important world reserve units. However, he received less dependence on the US economy.
If the price went beyond the set limits of the dual-currency basket, the state had the right to intervene in the quotes of the foreign exchange market. At the moment, this rule has lost its force, which happened after the global crisis. The government can make transactions with currency regardless of the exchange rate.
Free floating exchange rate
This regime provides for the complete refusal of the government of the state to regulate the national currency relative to the monetary units of other countries. A free-floating exchange rate means the movement of the exchange rate, which is determined only by the market laws of supply and demand.
The policy in question is used by a small number of countries. The more common is a regulated floating exchange rate. It enjoys greater relevance, since in it the price varies within the established framework. When it reaches one of the limits, the changed course is stabilized with the help of monetary authorities. Most often, conversion operations are conducted on the open market with reserve and national currencies.
The impact of conversion operations
Conversion operations are transactions that are aimed at the sale or purchase of monetary units that have pre-established deadlines, volumes and exchange rates. States using a floating and fixed exchange rates can perform these operations. They can affect the financial condition of the enterprise, a specific region and the economy of the country as a whole. To make a profit in this way, you should correctly understand this issue.