Up until 1914 FX rates around the globe were fixed as all currencies were linked to gold. What this then meant was that the value of each country’s currency was fixed (pegged) at a set rate in relation to gold ounces. It was more commonly referred to as the gold standard and as result allowed for unrestricted movement of capital. Plus it also meant that currencies and trade around the globe was much more stable.
But all this changed when World War I commenced and the use of the gold standard was then abandoned. This remained the case until after the end of the Second World War. Following the end of World War II a conference took place at Bretton Woods. This conference was held in order to try and generate economic stability around the world as well as helping to increase world trade.
Those who participated in this conference establish a set of basic rules and regulations that would help to govern international exchange. At this time it was agreed that again Foreign Exchange rates would be fixed (pegged). But this time all currencies would be fixed to the US Dollar. This in turn was then fixed to the value of gold.
What this then meant is that the value of each currency would be linked directly to the value of the US Dollar (USD). Therefore if the need arose for you to buy Australian Dollars (AUD) then its value would be expressed in US Dollars. In turn this was then determine the value of the gold. However should a country need to adjust the value of its currency it would have to approach the IMF to adjust the fixed Forex rates.
Fixed FX rates were maintained until 1971. The reason for the change was down to the fact that no longer was it possible for the USD to hold its value against the fixed Forex rates of USD against gold.
From this point forward many of the world’s major governments including Australia chose to adopt a floating FX rates system. Although attempts were made to try and go back to the fixed system that had played such an important role around the world use of it was eventually abandoned in 1985. Since this time none of the world’s major economies have chosen to go original fixed (pegged) FX rates system. In fact the use of gold to act as a peg for determining FX rates has now been abandoned altogether.
But why were fixed FX rates used?
The main reason for the use of fixed (pegged) FX rates was to help bring some stability to a currency. In fact even today in some of the worlds developing nations some of these countries may decide to fix its currencies FX rates so a stable atmosphere can be created. In turn this could help them to encourage investment from other countries.
People will choose to invest in a country where fixed FX rates are being used because they will know exactly what the value of the investment is.