Trade Forex : Defining Fixed Exchange Rate and its importance
As a trading enthusiast, it is important for you to be able to fully understand how they are valued and rated in the market if you wish to become an expert when you trade forex. In today’s post, we shall help you understand the fixed exchange rate concept. At the same time, we shall also help you identify its strengths and drawbacks including its importance to your trade.
The Fixed Exchange Rate System
Opposite to the floating system of currency, the fixed exchange rate for a currency occurs when the government of a particular country decides to peg the view of its currency to another currency or commodity. This practice is traceable back in 1944 when the Bretton Woods Agreement was adopted by certain countries. Discussing further, the agreement states that all countries under this pact should peg the value of their currency to US Dollar because during that time, USD was pegged to gold until 1971. During the term of President Nixon, his administration decided to take off the gold standard. Despite this decision, there were still several currencies around the world that were still tied to USD by choice. These countries opt to stay that way because of the fact that Us Dollar is regarded as the world’s reserve currency.
Advantage of Fixed Currency
1.Ability to have equal rate with the pegged currency
For traders who may be after profit and value of the currency, a legal tender under the fixed currency will help them enjoy an equal exchange value to the paired currency. If the currency is paired to a powerful currency such as the dollar or euro. This will therefore enable the trader to easily predict how much he will get from exchanging currency to another.
- Provides Stability of the Legal Tender
A fixed currency system will share almost the same power with the currency where it is pegged. Investors are usually enticed with this monetary system because it makes them easily predict their income due to the absence of sudden swings in the currency value. Because of this set up, they can create and plan strategies that mitigate potential problems before they even occur.
3. Lessens the risk of inflation
One reason for fixing your currency with a particular pair is inflation. We are all aware that increased inflation rates are dangerous for a particular economy. In order to lessen or eradicate such problems, certain countries benefit from a fixed exchange rate because you can be sure that the value of money is what it purchases for you. Thereby stabilizing prices of imported goods.
Amidst the advantages that fixed currency rate has to offer, some countries find it expensive to maintain such a system because it requires sufficient foreign exchange reserves to sustain it. As a country with fixed currency, some speculators who trade forex most of the time will also be dangerous as they could artificially provide a lower value for the currency in order to force the central bank to go against the fixed rating condition.