What is a Floating Currency?

//What is a Floating Currency?
What is a Floating Currency? 2017-10-04T21:16:36+00:00

Definition: A floating currency is a monetary system that is not backed by gold or assets and tends to fluctuate in value due to supply and market expectations. Its value is also determined by global demand and the level of foreign reserves.

What Does Floating Currency Mean?

What is the definition of floating currency? Floating currencies have a floating exchange rate, which changes based on the demand and supply mechanisms of the foreign exchange market. When the demand for a currency is high, the currency appreciates in value, thus impacting the country’s exports. A strong currency shifts consumers to a cheaper currency, thus lowering the demand for the exported goods.

In the long run, exporters have to lower their prices to attract consumers, thus lowering their profits and facing the risk of going out of business. Conversely, when the demand for a currency is low, the currency depreciates in value, thus impacting the country’s importers. A weak currency makes imported goods expensive. Therefore, consumers buy domestic goods, thus stimulating the domestic economy. In both cases, a floating currency tends to be volatile.

Let’s look at an example.

Example

In July 1944, the Bretton Woods Agreement introduced the concept of pegged currencies against the US dollar that was tied to the price of gold. In 1973, the system collapsed following a sharp appreciation in the price of the US dollar that raised a red flag with respect to exchange rates and the ties of the US dollar to the price of gold. From 1973 until today, countries are free to choose their exchange agreement.

Today, most of the widely traded currencies, such as the US dollar, the Euro, the British pound or the Japanese yen, have a floating exchange rate. However, central banks often raise concerns about the implications of adopting a floating exchange rate and how floating currencies can affect global foreign investment and monetary policies.

The main argument against floating exchange rates is that they enable monetary policy makers to use the exchange rate as a means to achieve a competitive advantage. The strong US dollar may appreciate or depreciate; yet the monetary policy makers use it as a means to stabilize the general price level.

Summary Definition

Define Floating Currency: A floating currencies are money systems that have a fluctuating value following the volatility in the foreign exchange market.