Detailed Summary
In a fixed exchange rate system, the value of a country's currency is set at a specific value relative to another currency or a basket of currencies. Such intervention is usually performed by the government or central bank to maintain the exchange rate stability. The system aims to reduce uncertainty in international transactions, facilitating trade and investment. Governments often announce that their national currency will be freely convertible at a fixed price into another asset, creating a trust that the currency will retain stable value over time. However, credibility hinges on two key factors: the ability to convert the currency in unlimited amounts and the fixed price set for conversion.
As markets evolve, many countries have moved away from gold-backed currencies to systems where trust in the economy replaces physical commodities. The section highlights the mechanics of exchange, detailing how currency value affects trade dynamics — with increased exports strengthening domestic demand and imports decreasing it. It also touches on the potential pitfalls governments face through speculation and the impacts of maintaining an unsustainable fixed rate, which can destabilize economies if not supported by adequate reserves.