Money Matters – Part II | Trade Samaritan

Money Matters – Part II

Theoretically speaking the floating exchange rate system lets the market forces determine the exchange rates, however in the real world scenario none of the economies leave the exchange rates at the mercy of market forces but do intervene through regulatory and monetary measures.

In Part I we have discussed fixed exchange regimes in this part we shall be discussing floating currency or floating exchange regimes.

Central banks play a critically important role in managing the floating exchange rate system as the Central bank intervenes and purchases/sells currencies of other countries to manage its own currency. It is observed that as the economies develop, they tend to move from fixed exchange rate system to managed float or free floating exchange rate regimes.

1.      Managed Float:  Managed float is a currency regime where the exchange rate is largely determined by demand and supply (market forces) and simultaneously the authorities do control and monitor the exchange rates through active intervention. This regime is also known as a ‘dirty float’. In today’s world of excessive trading in stock, currencies, commodities and bond markets, it has become imperative at least for the developing as well as not so developed economies to adopt managed float as their exchange regime. Monetary authorities under this regime typically intervene by changing the interest rates and buying or selling of domestic/foreign currencies.  For example, if the supply of the currency is excessive, driving the value down, the government can recall some of the currency into reserves to limit the supply and thereby increase the demand and value. Likewise, if the exchange rate climbs too high in the other direction, currency reserves can be released to increase the supply. This regime helps economies facing fierce political and social pressures. Countries here are required to control their own interest rates and need to have a clear monetary framework in place. A growing number of countries are moving towards managed or “dirty” floating systems. Brazil, Japan, Switzerland and Norway have all intervened in the currency markets in recent months.

Currency regimes

Economies who have successfully adopted Managed Float are Afghanistan, Egypt, India, Indonesia, Jamaica, Kenya, Pakistan, Mauritius, Singapore, Serbia, Ukraine, and Uganda.

2.     Independent or free floating system: Under independent floating system, the exchange rate is market determined, the value of the currency is determined solely on the foreign exchange market.  In free float regime, the government allows the market-determined exchange rate to prevail and does not attempt to influence its value. Instead, the government directs macroeconomic policy entirely toward domestic stabilization objectives such as output and inflation levels. Few countries follow purely free floats; even those that are independently floating occasionally intervene in foreign exchange markets and take into account the value of the exchange rate in making macroeconomic policy decisions. For instance the United States has intervened in the foreign exchange market on only a few occasions since the mid-1990s with the objective of countering ‘‘disorderly’’ market conditions. The Federal Reserve System also puts little weight on exchange rates in its policy deliberations. It is difficult to quote any single economy following strictly a free regime but placed below are a few economies who seldom manipulate their currency exchange rates.

currency regime free float

95% of currency trading is based on speculation however till date there is no model or strategy to predict the movement in the floating exchange rate regime.

Every economy adopts a currency model best suited for its demographic, socio-economic and political situation. Uncertainty of price movement happens to be the most interesting part of trading, and be it commodities, currencies, stock or bonds, trading runs on speculation and traders/money ex-changers make/lose their money to this market.

References

East Timor – by Hal Hill and Joao Saldanha
Forex Magnates
The Fiji Times
Foreign Exchange, An introduction to the core concepts – by Mark Mobius
EcoMonitor

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