What is the floating of the national currency?

Floating currencies, most notably the US dollar, the European euro, and the British pound sterling (Shutterstock)

Floating the currency is leaving it to the mechanisms of supply and demand, without interference from the central bank in determining its price, but this meaning does not exist in reality, even with floated currencies, known as hard currencies, which are: the US dollar, the European euro, the British pound sterling, and the Japanese yen. And the Swiss franc. Although global financial settlements are mostly carried out in these countries and are traded on international monetary exchanges, their governments usually target a specific price that achieves their economic interests, and work to stabilize it indirectly through various monetary policy mechanisms.

What are the types of currency float?

There are two types of flotation. The first, which we referred to in the definition of currency flotation, is absolute flotation, and the second type is managed flotation, that is, in which the central bank intervenes to direct the exchange rate up and down, as it deems it to be in the interest of the national economy.

Managed flotation is usually practiced by countries with strong economies, which have a significant share of international trade, so they turn to this type in order to aim to increase or reduce imports or exports of goods.

This was used in what is known as the currency war that the global economy witnessed after the 2008 international financial crisis, in order to maximize exports and reduce imports. Countries with weak economies may also resort to managed flotation, but this costs them great financial and economic burdens, which is what is achieved in the Egyptian case. , which resorts to foreign investments in local debt, in order to stabilize the exchange rate of the pound.

Why do countries resort to floating their currencies and what is its relationship to the IMF?

Countries resort to a policy of floating their currencies in the event that they suffer from unstable financial and economic conditions, which leads to making the possession of foreign currencies one of the important factors in market turmoil, as speculation abounds, and the currency exchange rate is out of the hands of the central bank and the banking system, and it is... However, the parallel or black market.

Hence, the state finds itself facing obligations greater than its capacity, while the available foreign exchange resources in the country are outside its control, and in the hands of the central bank, the banking system, and financial institutions. Therefore, it resorts to floating the currency within the framework of an economic program, to try to reach a state of stability. The politician.

It was known, through follow-up and practice, that floating the local currency in troubled economies comes through the commandments of the International Monetary Fund, or within the framework of what is known as the Monetary Fund’s agenda, which usually includes a package of measures, including floating the currency price, liberalizing the interest rate, and reducing... The number of employees in the public sector, and adopting a program to privatize the public sector, liberalize foreign trade, and open the way for foreign investments.

Egyptian pound and US dollar (Shutterstock)

How is the currency exchange rate determined?

Since 1971, the world has abandoned the gold rule in determining the currency exchange rate, and there has become a basket of determinants of the currency exchange rate, the first of which is the foreign exchange balance, the gold balance, and the performance of the gross domestic product. Countries that have a domestic product that has a high added value increase the value of their currency significantly. As there is demand for its products abroad, it increases its supply of foreign currencies. Therefore, central banks seek to create a balance of foreign exchange and gold, which helps to reach a balanced exchange rate that preserves their economic interests abroad, works to stimulate the local economy, and preserves society’s capabilities of... Savings and wealth.

There are several types of exchange rates, the first of which is the administrative exchange rate, which does not depend on the mechanisms of supply and demand, but rather depends on a decision from the monetary authority at a specific price.

The second is the free exchange rate, which is the opposite, as the currency exchange rate is determined based on supply and demand mechanisms and without interference from the monetary authority.

The third type is the managed exchange rate, where the monetary authority intervenes in determining the exchange rate through the open market mechanism, which means that the monetary authority manages the market through its intervention in buying and selling to reach a balanced price that it believes achieves the benefit of the national economy. When it sees that the exchange rate of the foreign currency is in rise, it intervenes by offering its foreign currency to increase the supply and the price decreases, and if it sees that the foreign currency exchange rate decreases more than the equilibrium price, it intervenes by purchasing to maintain the market’s balance at the target price.

The dollar among a number of different currencies (Gate)

What are the advantages of flotation?

Floating the price of the currency in developing economies is considered a risk with uncalculated consequences, especially if it takes place in a country with a weak political system that does not enjoy transparency and implementation of the rule of law.

But within the framework of the economic dimensions, there are a group of positives that can be achieved from the process of floating the currency, the first and most famous of which is the elimination of the black market, because dealers find before them a single exchange rate in banks and with all foreign currency dealers.

The second thing is that floating helps eliminate a negative phenomenon, which is dollarization, that is, the tendency of citizens to keep the dollar, or seek to buy the dollar without any need, but their main purpose is to preserve their savings, or to speculate on its price, to obtain profits.

What are the disadvantages of flotation?

Taking the decision to float the currency, in light of turbulent economic conditions, is usually accompanied by a group of negatives on the economic and social levels. The first of these negatives is high inflation rates, the prevalence of a state of stagnation and anticipation to reach a real monitoring of market movement. Therefore, unemployment rates rise in the short term, and damage is also caused. Both producers and importers, due to the rise in the production and import bill, and creditors also suffer a major shock due to the decline in their wealth represented by the debts owed to them by others. The country indebted to the outside world is also harmed, and the bill for paying the bill for its external debt burdens rises, especially in light of the poverty of its foreign exchange resources.

Floating a currency is leaving it to the mechanisms of supply and demand to determine its value against other currencies (Shutterstock)

Who are the winners?

At the forefront of the winners from currency flotation are those who have previous savings in foreign currencies, as their wealth doubles, and immediately after the currency flotation process occurs, they intend to buy assets, such as real estate, factories, farms, or cars, because of the wealth that has fallen to them as a result of the currency flotation.

The second category is debtors, especially those with debts owed to banks and official financial bodies, as they can repay their debts for less than the real value at which they obtained the debts, and by selling some of their assets they can repay a large portion of their debts.

The third category is the large merchants, or what are called wholesalers or agents, or large importers, who have a large stock of goods, and they raise the prices of their stock of goods according to the new prices after the flotation.

The fourth category is producers who aim to export, and rely in their production on local supplies, provided that they have high production flexibility that meets the demand for local goods, after the flotation, as importers of the goods of the country in which the flotation took place are motivated to take advantage of the advantage of the decline in the value of the currency, to obtain Larger quantities of goods with the same value of foreign currencies that were imported with before.

The fifth category that benefits is the government, through the significant reduction in the value of its local debts, which reduces the burden on the state’s general budget.

The dollar is considered the most important currency that countries are keen to maintain a stock of (Al Jazeera)

Who are the losers?

A group of citizens are harmed, within the country that adopted the policy of floating its currency, and at the forefront of these are those with savings in local currencies, as their purchasing value decreases by the amount of the decline in the value of the currency after the float, and they actually lose an important part of their wealth.

The second category is creditors in local currencies, as the value of their debts owed to others decreases in real value after flotation, and what they obtain does not compensate them for the real value of their debts that they are entitled to, so long-term debts in this case are considered a major loss for creditors.

The third category is the owners of goods whose price cannot be raised at a rate equal to the value of the decline in the value of the currency as a result of the flotation. For example, real estate, as a capital good, is difficult to raise its price by 100% within a few days, so the market for such goods is exposed to a major recession.

The fourth category is importers, as they find themselves facing a high bill for the goods they want to import, and producers who depend on imported production requirements are harmed, as they are forced to raise the prices of their goods by the amount of the increase in the price of foreign currencies, which leads to their inability to compete in the local market. Or the international market, so industrial activities shrink in light of the floating of the currency, and trade and service activities revive.

The fifth category affected is employees and those with fixed incomes, because employees’ salaries cannot be increased to the same extent that occurs with the decline in the value of the currency as a result of financing, and it is difficult for an employer in the government or the private sector to raise salaries by 50% or 100%, for example, so what if we do so? Did the flotation lead to a decline in the value of the currency by more than 580%, as is the case with Sudan?

Source: Al Jazeera