A good way to understand the floating and fixed exchange rate system is to compare it to free market principles and centralized governments. In fact, centralized governments like China and the Soviet
Like a free market, where supply and demand laws rule businesses, and businesses have to create value to attract customers, floating exchange rate systems are tied to the movement of supply and demand (Guevara, 2013). Governments do not intervene in this system; they do not set the rates or tie it in to their own currencies.
On the other hand, a fixed exchange rate is exactly how it sounds – it is fixed. Just as the old Soviet Union’s communist regime ran its economy, so the fixed exchange rate is determined by a country’s government. China is a prominent, modern-day example of a country using the fixed exchange rate system.
Some advantages of the floating system a natural balancing system, the ease of use, and the lack of need in keeping large foreign currency reserves (kantox.com). What is meant by these? For the first (natural balancing system), imagine a country’s currency is depreciating. This would drop the price of its exports, which would then increase the demand. An increase in demand would also increase a country’s exports, and balance is eventually restored in a natural way. For the second (the ease of use), is that it does not require any management or government interference. For the third (not keeping foreign currency reserves), a government holds and inserts currency into the economy in order to change and balance its value. This type of intervention does not exist in a floating system, so this step is not necessary.
Proponents of the fixed exchange rate say that the system can prevent monetary shocks (Kenen, 2000). This happens when a country, observing the ebbs and flows of supply and demand, raise or lower the value of the currency to keep a disaster from happening. The author, in opposition to this idea, said that this only works with a competent central bank and perfect system. Otherwise, errors in this system will end up flowing over to other countries.
Another big advantage to the floating exchange rate system is the ability to halt the progress of inflation, which raises the price of domestic goods.
For a multinational business, the choice between the two comes down to how much risk a business is willing to take on. As stated, a floating exchange rate can be prone to monetary shock – severe highs and severe lows can and do occur, because no control is placed over a floating exchange rate system.
A fixed rate system can be less prone to shock and presents more stability. A business would have to do determine if it is content with moderate and consistent profits, or if it would prefer to chance it for the floating system’s potential for higher profits.
If anyone here has investments in an IRA or a 401(k), there are investments that are risky and some that are safe. Depending on your personal tolerance level of risk, you can roll the dice and aim for a higher rate of return (floating exchange rate system), or you can insure a 1% rate of return by keeping it in various money market accounts (fixed exchange rate system).
Guevara, F. (2013). What is the Best for International Business: Fixed or Floating Exchange Rate Regime? Retrieved from https://buildandbattle.wordpress.com/2013/02/04/what-is-best-for-international-business-fixed-or-floating-exchange-rate-regime/
Kenen, P. B. (2000). Fixed versus floating exchange rates. Cato Journal, 20(1), 109-113. Retrieved from https://saintleo.idm.oclc.org/login?url=https://search-proquest-com.saintleo.idm.oclc.org/docview/195591393?accountid=4870
Advantages of a Floating Exchange Rate. (n.d.). Retrieved from https://www.kantox.com/en/glossary/floating-exchange-rate/