Exchange rate regimes

The price of a currency can go up or down. But who decides that price? It depends on the country.

There are four main ways of doing it. From the freest to the most closed.

First: the floating rate. The market decides, at every moment, by supply and demand.

That is the case for the euro, the dollar, the yen. The price moves all the time, but adjusts by itself.

Second: the pegged rate. The central bank promises a level, and defends it.

Hong Kong, for example, has kept its dollar in a narrow band against the American dollar since nineteen eighty-three.

To defend that level, the central bank buys back its own currency when everyone is selling it. With its reserves.

The day the reserves are no longer enough, the peg gives way. And it gives way all at once.

In nineteen ninety-two, the United Kingdom was defending the pound. On the sixteenth of September, it had to give up.

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In two thousand fifteen, Switzerland dropped its floor against the euro overnight. The franc soared within minutes.

Behind all this, a hidden rule: you cannot have everything at once.

A fixed rate, free capital flows, and freely chosen interest rates. You must give up one of the three.

Economists call it the impossible trinity. Each regime is a choice within this triangle.

Third regime: dollarisation. You give up your currency, and use someone else's.

Ecuador adopted the American dollar in two thousand. Panama has used it for more than a century.

No more currency crisis possible. But no more central bank of your own to cut rates when the country is struggling.

Fourth: exchange controls. The state limits who can buy foreign currency, and how much.

France had them until the late eighties. Iceland, after its two thousand eight crisis, for more than eight years.

Often, a second, parallel market appears. In Argentina, people follow the "blue" dollar rate, far dearer than the official one.

When two prices exist for the same currency, it is a sign the official price does not tell the whole story.

For a saver, the question is simple. Can my money get out, and at what price?

An exchange rate regime is a promise. The more rigid it is, the more its breaking hurts.