MVP ARCHIVE HISTORY | Economic : Floating Exchange Rates - A World Where Currency Value Shifted from "Fixed" to "Floating"

MVP ARCHIVE HISTORY > Economic > Floating Exchange Rates - A World Where Currency Value Shifted from "Fixed" to "Floating"

Floating Exchange Rates - A World Where Currency Value Shifted from "Fixed" to "Floating"

World War II In the post-war world, the Bretton Woods System supported the international monetary order.
However, in 1971, the United States suspended the convertibility of the dollar into gold, and in 1973, major nations moved away from a system of maintaining fixed exchange rates to a world where currency exchange ratios fluctuate in the market.

Floating Exchange Rates era.

Fixed Exchange Rates

In the Bretton Woods System designed in 1944, countries based their policies on maintaining a fixed exchange rate between their national currency and the U.S. dollar.
When exchange rates are fixed, it is easier to predict exchange ratios for international trade, and companies investing overseas can mitigate exchange rate fluctuation risks.
For a world advancing post-war reconstruction and the rebuilding of international trade, stable exchange rates held great significance.

It also meant that even if the price demanded by the market differed from the price the government sought to maintain, that exchange ratio had to be upheld.

What is required to fix rates?

Exchange rates cannot be fixed simply by declaration.
For example, if a national currency is being sold in large quantities and its value is about to fall, the government or central bank must intervene in the market.
To support the currency, they sell foreign currencies such as the dollar.
Therefore, countries maintaining a Fixed Exchange Rate system require sufficient Foreign Exchange Reserves .

If a large gap arises between economic reality and the fixed exchange rate, the burden of defending the fixed rate increases.
In other words, the Fixed Exchange Rate system was also a system where the state assumed the policy burden of maintaining stability in exchange for achieving exchange rate stability .

Pressures on the Bretton Woods System

As the post-war global economy expanded, pressure began to mount on the Bretton Woods System itself, and there were limits to the U.S. gold reserves backing the dollar.
This was a problem later known as the Triffin Dilemma .

Nixon Shock | 1971

On August 15, 1971, U.S. President Richard Nixon announced the suspension of the convertibility of the dollar into gold, the so-called Nixon Shock .
However, the world did not immediately shift to a Floating Exchange Rate system at this point, and the Smithsonian Agreement was concluded in December of that year.

1973 | Floating Exchange Rates

In 1973, major nations moved away from the Fixed Exchange Rate system one after another and shifted to a Floating Exchange Rate system.
Japan also shifted the yen to a Floating Exchange Rate system in February of the same year, changing the basic structure for determining currency exchange ratios.

A system where exchange rates fluctuate based on supply and demand in the foreign exchange market. Global currencies were freed from fixed exchange ratios, marking the beginning of a world where
the value of currency itself is constantly moving.

Foreign Exchange Market

In a Floating Exchange Rate system, currencies themselves are bought and sold in a massive market.
Corporations, banks, investors, governments, central banks, and institutional investors.
Various entities exchange currencies for different purposes, and these countless transactions aggregate to form exchange rates.

Demand and Supply

The basic mechanism is the same as in other markets.
However, in the actual foreign exchange market, there are a vast number of factors to consider.
Interest rates, inflation rates, trade balances, government debt, monetary policy, political situations, wars and international conflicts, and the future expectations of market participants.
Exchange rates continue to move while reflecting information and expectations gathered from all over the world.

Currency Appreciation / Depreciation

Under a floating exchange rate system, changes in currency value are transmitted to various parts of the economy.
For example, if the value of the yen falls against the dollar (yen depreciation), it may increase price competitiveness for companies exporting goods from Japan to overseas.

On the other hand, when importing crude oil, natural gas, food, raw materials, etc., from overseas, the yen-denominated price tends to rise, increasing costs for importing companies, and if those costs are passed on to product prices, it also affects consumer prices.
The costs required for overseas travel and studying abroad also increase.
Conversely, if the yen appreciates, the relationship moves in the opposite direction.

The Mechanism of Automatic Adjustment

A floating exchange rate system has an adjustment function different from a fixed exchange rate system.
When a country's economic situation changes, that impact is reflected in the exchange rate.
For example, if a currency falls, the price competitiveness of exports generally tends to increase, while imports become more expensive.

These changes affect trade and capital flows, leading to adjustments in the overall economy.
In a floating exchange rate system, a mechanism is added where the exchange rate itself changes to absorb economic shifts.

Monetary Policy

Another major change is the monetary policy of central banks.
Under a fixed exchange rate system, maintaining the exchange rate can strongly constrain monetary policy, because if interest rates are changed freely, cross-border capital flows occur, putting pressure on the fixed exchange rate.

A floating exchange rate system allows the exchange rate itself to move.
Therefore, while central banks cannot completely ignore the exchange rate, they can expand the room for monetary policy that prioritizes the domestic economy.

Central Banks | Is the market completely free?

The name "floating exchange rate system" might make it seem like a system where the government and central bank do not intervene in the foreign exchange market at all, but in reality, that is not the case.

If exchange rates fluctuate rapidly in a short period, it can cause significant confusion in the economy and financial markets, so central banks and governments may, as necessary, conduct foreign exchange intervention.
Furthermore, interest rate policy itself also significantly affects exchange rates.

In other words, many of the current major currencies exist within a system where prices are formed in the market, while the state and central banks also exist as important participants.

Managed Float

Not all countries in the world adopt the same exchange rate system.
The current international monetary system is not unified by a single system, but rather different exchange rate systems coexist, with floating exchange rates at the center.

The Dollar did not disappear

In 1971, the convertibility of the dollar to gold was suspended.
In 1973, major countries shifted to a floating exchange rate system, yet the US dollar did not disappear from the center of international currency, and it continued to be used in various places around the world.
The dollar-centered global financial system was maintained, and even after losing its connection to gold, the international financial network centered on the dollar remained.

From fixed to floating

Floating exchange rates - if you only explain the transition as 'the exchange rate that was decided by the government is now decided by the market,' its historical significance is difficult to see.

The international monetary order centered on stable fixed rates created by the post-war world itself changed, and in its place, a new system was formed.
It was a more fluid international financial system where markets, central banks, interest rates, capital flows, national policies, and investor expectations all influenced each other to determine currency value.

From Gold to Market

Gold Standard → Great Depression → Bretton Woods System｜1944 →
Fixed Exchange Rates → Nixon Shock｜1971 → Smithsonian Agreement｜1971 → Floating Exchange Rates｜1973 → Global Foreign Exchange Market → Modern International Financial System

Under the gold standard, the value of currency was connected to gold, and under the Bretton Woods System, world currencies were connected to the dollar, and that dollar was connected to gold.

And under floating exchange rates, that fixed connection was removed, and while currency value became free, it also became uncertain; exchange rates change every day, and those changes propagate to trade, companies, prices, investments, resources, and household budgets.

Currently, a massive amount of currency is exchanged globally every day.
It is a price that emerges as a result of the intersection of economic activities of nations, companies, central banks, investors, and people around the world.

A floating exchange rate system is a system that liberated currency from a fixed standard, and at the same time,
it is also a mechanism that reflects the changes of the global economy itself in the price of currency.

MVP ARCHIVE HISTORY > Economic > Floating Exchange Rates - A World Where Currency Value Shifted from 'Fixed' to 'Floating'