# Understanding Floating Exchange Rates: Key Concepts and Differences

> **Definition**
>
> A floating exchange rate is an exchange rate system where a currency's value is based on supply and demand in the foreign exchange market.

## What Is a Floating Exchange Rate?

A floating exchange rate is a system where a currency’s value is set by [supply and demand](https://www.investopedia.com/articles/economics/11/intro-supply-demand.asp) in the foreign exchange market. This system became common after the end of the Bretton Woods system and is contrasted with [fixed exchange rates](https://www.investopedia.com/terms/f/fixedexchangerate.asp), which are controlled by the government. Floating rates cause currency values to change, which can affect things like international travel and trade. Understanding floating and fixed exchange rates is important for trading and economic policy.

### Key Takeaways

*   A floating exchange rate is set by the forex market and reflects supply and demand for a currency.  
    
*   Floating exchange rates became more common after the end of the gold standard and the Bretton Woods system.  
    
*   Central banks may intervene in floating exchange rates to stabilize markets or adjust currency values.  
    
*   The U.S. dollar operates on a floating exchange rate, fluctuating based on market conditions.  
    
*   A currency's high or low value can impact the economy by affecting trade and debt repayment.

## Comparing Floating and Fixed Exchange Rate Systems

In floating exchange rate systems, long-term currency prices change based on economic strength and [interest rate differences](https://www.investopedia.com/terms/i/interest-rate-differential.asp) between countries. Currency prices can be determined with a floating rate or a fixed rate.

A floating rate depends on supply and demand in the open forex market. If the demand for a currency is high, its value rises. If demand is low, this will drive the currency price lower. After the Bretton Woods system collapsed between 1968 and 1973, most major world currencies were allowed to float freely.

Central banks determine fixed or pegged rates. The rate is pegged against major currencies like the U.S. dollar, euro, or yen. Governments buy and sell their currency to maintain the pegged rate. Countries like Jordan and the United Arab Emirates [peg their currencies to the U.S. dollar](https://www.investopedia.com/articles/forex/061015/top-exchange-rates-pegged-us-dollar.asp). 

> **Tip**
>
> See Investopedia's choices for Best Forex Brokers.

## Impact of the Bretton Woods Conference on Exchange Rates 

The [Bretton Woods](https://www.investopedia.com/terms/b/brettonwoodsagreement.asp) Conference established a gold standard for currencies in July 1944. A total of 44 countries met, with attendees limited to the Allies in World War II. The Conference established the [International Monetary Fund (IMF)](https://www.investopedia.com/terms/i/imf.asp) and [the World Bank](https://www.investopedia.com/terms/w/worldbank.asp), setting guidelines for a fixed exchange rate system.

A gold price of $35 per ounce was established, with participating countries pegging their currency to the dollar. Adjustments of plus or minus 1% were permitted. The U.S. dollar became the [reserve currency](https://www.investopedia.com/terms/r/reservecurrency.asp) through which central banks could adjust or stabilize rates.

The first large crack in the system appeared in 1967, with a run on gold and an attack on the British pound that led to a 14.3% [devaluation](https://www.investopedia.com/terms/d/devaluation.asp). President Richard Nixon removed the United States from [the gold standard](https://www.investopedia.com/ask/answers/09/gold-standard.asp) in 1971. By 1973, the system had collapsed, and participating currencies were allowed to float freely.

![History of Floating Exchange Rate](https://www.investopedia.com/thmb/AeHXm1-ll_jL-rNNOT2gJZIvbw0=/1200x0/filters:no_upscale():max_bytes(150000):strip_icc()/dotdash-floatingexchangerate-FINAL-d2e0c610285d484eb8c88396e78c6a6d.jpg)

*— Investopedia / Sabrina Jiang*

## How Currency Interventions Affect Exchange Rates

Short-term moves in a floating exchange rate currency reflect [speculation](https://www.investopedia.com/terms/s/speculation.asp), rumors, disasters, and everyday supply and demand for the currency. If supply exceeds demand, the currency falls; if demand exceeds supply, it rises. Central banks may buy or sell local currency in a floating rate system to stabilize markets or change the rate.

A currency that's too high or too low impacts a nation's trade and debt-paying ability. The government or central bank takes steps to adjust its currency to a better price. G-7 central banks, like those in Canada, France, and the U.S., often coordinate interventions.

A prominent example of a failed intervention occurred in 1992 when financier [George Soros](https://www.investopedia.com/terms/g/soros.asp) spearheaded an attack on the British pound. The currency entered the European [Exchange Rate Mechanism (ERM)](https://www.investopedia.com/terms/e/exchange-rate-mechanism.asp) in October 1990; the ERM was designed to limit currency volatility as a lead-in to the euro, which was still in the planning stages. The Bank of England was forced to devalue the currency and withdraw from the ERM. The failed intervention cost the U.K. Treasury a reported £3.3 billion. Soros made over $1 billion.

## Real-Life Applications of Floating Exchange Rates

A floating exchange rate means the value of currencies fluctuates and the exchange rate changes constantly. Let's say you travel to Europe from the U.S. If you need to exchange U.S. dollars to euros, you'll notice the exchange rate changes, even daily. One day, you might get 0.91 euro for every dollar, and another day, this can drop to 0.87 euro. How much you receive will impact how much you spend while you are abroad and how much you bring back to the U.S.

## What Is an Example of a Floating Exchange Rate?

An example of a floating exchange rate would be on Day 1, 1 USD equals 1.4 GBP. On Day 2, 1 USD equals 1.6 GBP, and on Day 3, 1 USD equals 1.2 GBP. This shows that the value of the currencies float, meaning they change constantly due to the supply and demand of those currencies.

## Is the U.S. Dollar a Floating Exchange Rate?

Yes, the U.S. dollar is a floating currency, meaning that its value depends on the supply and demand of the dollar.

## What Are the Benefits of a Floating Exchange Rate?

The benefits of a floating exchange rate include the lack of need for large reserves and the ability to manage inflation.

## The Bottom Line

Floating exchange rates are set by supply and demand in the open market instead of being fixed by governments. Most major currencies use floating rates, especially after the Bretton Woods system collapsed. Floating rates help manage inflation and reduce the need for large currency reserves, unlike fixed rates, where governments set currency values against another currency. These rates affect travel, trade, and international financial transactions, though central banks may intervene to stabilize their currency.

> **Article Sources**
>
> 1.  International Monetary Fund. "[Reinventing the System (1972-1981)](https://www.imf.org/external/np/exr/center/mm/eng/mm_rs_01.htm)."
>     
> 2.  World Bank. "[Official Exchange Rate](https://data.worldbank.org/indicator/PA.NUS.FCRF?end=2022&locations=BH-BZ-CU-DJ-HK-JO-LB-OM-PA-QA-SA-AE-ER&start=1960&view=chart)."
>     
> 3.  U.S. Department of State. "[Bretton Woods-GATT, 1941-1947](https://history.state.gov/milestones/1937-1945/bretton-woods)."
>     
> 4.  Federal Reserve History. "[Creation of the Bretton Woods System](https://www.federalreservehistory.org/essays/bretton-woods-created)."
>     
> 5.  House of Commons Library. "[Pound In Your Pocket: Devaluation](https://commonslibrary.parliament.uk/pound-in-your-pocket-devaluation-50-years-on/)."
>     
> 6.  Federal Reserve History. "[Nixon Ends Convertibility of U.S. Dollars to Gold and Announces Wage/Price Controls](https://www.federalreservehistory.org/essays/gold-convertibility-ends)."
>     
> 7.  U.K. Parliament. "[Exchange Rate Mechanism](https://api.parliament.uk/historic-hansard/commons/1990/oct/15/exchange-rate-mechanism)."
>     
> 8.  History Defined. "[How George Soros Shorted the Pound and 'Broke' the Bank of England](https://www.historydefined.net/how-george-soros-broke-the-bank-of-england/)."