Why Forex?: The Free-Floating System

The Beginning of the Free-Floating System

Signing the European Monetary System agreement at the Bank for International Settlements, 13 March 1979.

After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971. This agreement was similar to the Bretton Woods Accord, but allowed for a greater fluctuation band for the currencies. In 1972, the European community tried to move away from its dependency on the dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium and Luxemburg. The agreement was similar to the Bretton Woods Accord, but allowed a greater range of fluctuation in the currency values.

Both agreements suffered mistakes similar to the Bretton Woods Accord and, in 1973, collapsed. The collapses signified the official switch to the free-floating system. This occurred by default, as there were no new agreements to take their place. Governments were now free to peg their currencies, semi-peg or allow them to freely float. In 1978, the free-floating system was officially mandated.

In a final effort to gain independence from the dollar, Europe created the European Monetary System in July of 1978. Like the previous agreements, it failed in 1993, but what followed was an evolution from a combination of the EMS and the Bretton Woods Accord.

Today, the major currencies, such as the U.S. dollar, Euro, British pound, Swiss franc and the Japanese yen, move independently from other currencies. The currencies are traded by anyone who wishes, including an influx of speculation by banks, hedge funds, brokerage houses and individuals. Only on occasion do some of the central banks intervene to move or attempt to move currencies to their desired levels. The underlying factor that drives today's forex markets, however, is supply and demand. The free-floating system is ideal for today's forex markets. The supply and demand of currencies are driven by three factors, including interest rates and interest rate differentials, commodities and global trade. The forex market is the prime market of the world by all which all others can be considered derivatives (like futures and options).

Top

Next: Forex Vs. Other Markets

Request More Information

CD01U.041.111307