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The History of the Forex:From Bretton Woods to the Present

Jun 4, 2008
The Bretton Woods System lasted 27 years, but when it was finally decreed that gold was no longer the standard for backing US dollars in foreign reserves in August of 1971, the US gold reserves were literally depleted beyond replenishment. Despite all this, the Bretton Woods System left enough of a historical legacy that there is still a significant impact being felt on the international economic climate in the world today.

That legacy can be seen in the current existence of the three international agencies that were created in the early years of the system (see The History of the Forex: from Beginning to the End of Bretton Woods). The exception is that the GATT became the World Trade Organization.

After the demise of the Bretton Woods System, the Jamaica Agreement of 1976 implemented the worldwide use of floating exchange rates. This permanently abolished the gold standard as we know it today. However, this does not infer that government's accepted a 100% free-floating exchange rate system. As it currently stands, most of the world's governments use one of the three following exchange rate systems:

* Dollarization

* Pegged Rate

* Managed Floating Rate

Dollarization occurs when a country decides to use the currency of another currency and ceases to issue its own. What results is that the country that employs this practice is viewed as a viable entity for stable investments. The pitfall with dollarization is that the central bank of that particular country can no longer formulate monetary policy or print the former currency. A perfect example of dollarization lies in the fact that the US dollar is currently El Salvador's currency.

Pegged Rates occur when a country affixes its current exchange rate to that of another country creating more stability than the normal "float." This enables the exchanging of that country's currency at fixed rates with either a single or specified group of foreign currencies. The only time there are fluctuations in the currency's value is when the pegged currencies experience any changes. The downside with pegged rates is that the value of the currency is at the mercy of the pegged currency's economic environment.

A good example of pegging occurred between 1997 and 2005 when China pegged the Yuan to the US dollar at a rate of 8.28 Yuan to $1 USD. It follows (with pegging) that if the USD begins to appreciate substantially against all other currencies, that the Yuan would follow suit and appreciate as well. However, this may not be what the central bank of China wants.

Managed Floating Rate this particular system results when the exchange rate of a country is allowed to freely change its value based on the factors of supply and demand. However, extreme fluctuations in exchange rates could result in the central banks or even the government of the country intervening in order to stabilize the fluctuations. Let's say, for example, that the currency of a particular country is depreciating to such an extent that it will fall far beyond any acceptable level.

The country's government may intervene by raising the short-term interest rate so as to offset the depreciation of the currency. The hike in the rate would normally cause the exchange rate to appreciate slightly, but this is only a simple example. Characteristically, there other tools that a central bank would employ to offset any major exchange rate fluctuations.
About the Author
Justin Stewart has used software to automatically trade the forex market allowing him to earn a living without lifting a finger, even while he sleeps. You can use the same forex software to get the same results.
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