A Quick Look At Floating Currencies

Let's divide currencies into two types - fixed and floating.

When I say 'fixed', I don't mean like a neutered dog, but a fixed exchange rate. Central banks that issue fixed currencies (also called convertible currencies) need to get some other thingy, like gold or another country's currency, before they can issue their own.

The important thing to understand is that the central bank decides what the exchange rate is going to be between their currency and this other thingy. It takes some effort on their part, which may explain why senior central bankers sound like jaded wheeze-bags!

A floating currency, such as the Japanese yen, may actually float on water. But if we're talking about all floating currencies, then we can say that the market decides on the exchange rate of your currency, which is the opposite to a fixed currency.

More Opposite Behaviours

If you look at the Hong Kong dollar, that has what's called a hard currency peg, which means that the exchange rate with the US dollar is rock solid. If people on Wall Street begin buying and selling Hong Kong dollars, the exchange rate will remain the exact same but Hong Kong's interest rate will go up and down.

If the Wall Street foreign exchange traders were to do the same thing with the yen, the exchange rate would go up and down, but the Bank of Japan's interest rate would be unchanged. It's the opposite!

So What?

It's just another one of those things that most economists don't seem to understand. In fact, they've probably never even considered that opposite behaviours exist! They just treat all currencies as though they were fixed/convertible/abacus-style currencies.

As you might have guessed, this causes problems for society. That means it causes problems for you, unless you're a bank or someone who invests in government securities, in which case you receive interest money just because you have more money than you need. They wouldn't be receiving that welfare if economists understood the differences between fixed and floating currencies.