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If you’ve ever embarked on a foreign holiday, you’ll probably have exchanged your local currency for that of your destination country.

This essentially requires you to ‘buy’ a specified amount of currency based on a real-time exchange rate, with local banks and credit unions typically offering the most competitive offerings.

This so-called ‘“exchange rate” also determines prices in the global forex market, as it describes the fundamental value of one nation’s currency against another. For example, if the popular EUR/USD exchange rate is fixed at 1.2500, this means that a single Euro can be exchanged for 1.2500 US dollars.

In this post, we’ll explore the history of exchange rates in the forex market, while asking what types of exchange rates exist in 2021.

From Bretton Woods to Free-Floating Exchange Rates

Prior to the Second World War, most countries across the globe followed the gold standard. This meant that each nation guaranteed that it would redeem its currency for its value in gold, until the Great Depression of 1929 sent the underlying price of gold soaring out of control.

To replace this, the Bretton Woods System was conceived in 1944, with this establishing the International Monetary Fund (IMF) and creating a fixed exchange rate system.

This worked by establishing a gold price of $35 per ounce, with participating nations subsequently pegging the value of their currency to the US dollar (which continued to adhere to the gold standard). The reason for this was simple; as the US held three-quarters of the world’s supply of gold at that time, while it was also widely considered to be the most dominant reserve currency across the globe.

This system remained in place until the early 1970s, although the first cracks began to appear in 1967. At this time, a sustained run on gold and an attack on the British pound led to a whopping 14.3% devaluation, with President Richard Nixon removing the dollar from the gold standard by 1971.

By late 1973, the system had collapsed completely, creating free-floating exchange rates between the vast majority of developed countries across the globe.

What Types of Exchange Rates Dictate the Current Marketplace?

These free-floating exchange rates remain largely in place to this day, and are influenced by concepts such as supply and demand in the market and macroeconomic factors like interest rates, inflation and capital inflows.

With this type of exchange rate, currencies change in relative value all the time, while economic news, geopolitical events and key data releases can all contrive to trigger real-time fluctuations.

For example, the influential US Dollar Index recently rose 0.6% intraday as the greenback soared on better than expected economic data and highly positive PMI numbers. This saw the dollar make rapid gains against the pound and the Euro, creating a sudden opportunity for investors to profit.

This at least partially explains why economic calendar apps are so popular amongst forex traders, as they detail key economic events and can be customised to target specific countries and currencies for the purpose of informing future trades.

Not all currencies operate according to a free-floating exchange rate, however, with some assets from developing economies slightly restricted and pegged to another fiat currency.

For example, the Hong Kong dollar is pegged to the greenback in a range of 7.75 to 7.85, creating a narrow trading range that minimises volatility.

The UAE dirham has also been pegged to the USD since 1997, while small European currencies such as the Andorran franc, the Austrian Schilling and the Bosnian Mark are currently pegged to the Euro.

In addition to stabilising exchange rates between trading partners, pegging to a major currency such as the dollar keeps prices low and enables a developing country to retain competitive exports.

All major currency pair prices are dictated by the free-floating exchange rate, however, including the most traded assets such as the EUR/USD and the USD/JPY.