FLOATING AND FIXED EXCHANGE RATES

The FX market was not always so volatile or quick to respond to changing events. Today's FX rates float; they fluctuate according to market value. However, for most of the 20th century, currency rates were fixed, or kept at the same level, according to the amount of gold they could be exchanged for; they did not change according to market pressures. This system was called, aptly enough, the gold-exchange standard. For example, if one ounce of gold was worth 12 British pounds or 35 U.S. dollars, the exchange rate between the dol­lar and the pound would remain constant at just under three to one.

In addition to serving as a common measure of value, the gold-exchange standard helped to keep inflation under control by keeping the money supplies in the gold-exchange standard economies relatively stable. And, of course, long-range planning was much easier because exchange rates changed infrequently.

The gold-exchange standard should not be confused with the gold standard. The gold standard refers to the system by which U.S. households and businesses could exchange their dollars for gold. This practice was terminated in 1933 during the Great Depression, in large part to allow freer expansion of the money supply. However, foreign governments still were able to exchange their dollars for gold until 1971 when the United States abandoned the gold-exchange standard.

This change marked the end of the "Bretton Woods" international economic system, which had been effective since 1944 when leaders of allied nations met at Bretton Woods, New Hampshire, to set up a stable economic structure out of the chaos of World War II. The U.S. dollar was fixed at $35 per ounce of gold and all other currencies were expressed in terms of dollars.

BEGINNING OF FLOATING EXCHANGE RATES

The Bretton Woods system began to weaken in the 1960s, when

Americans sharply increased their consumption of imported goods. As foreigners accumulated large amounts of U.S. dollars from sales of exports to the United States, these exporting countries began to express concern that the United States did not have enough gold to redeem all of the dollars held overseas. A look at some data shows why. In 1950, U.S. gold reserves were about $23 billion and the amount of dollars being held by foreign countries was $8 billion. However, by 1970, gold reserves had fallen to only $11 billion and dollars held by foreigners stood at $47 billion.

Clearly, if all the countries that held dollars chose to exchange them, the United States would quickly run out of gold. This situation could not be sustained, and in 1971, President Nixon announced that U.S. dollars would no longer be convertible into gold. By 1973, this action led to the system of "floating" exchange rates that exists today, where currencies rise and fall in value according to forces of supply and demand. After the abandonment of the gold-exchange standard, the foreign exchange market quickly went from a relatively unimportant financial specialty to the forefront of international economics.

Date: 2015-12-24; view: 800