The Floating Exchange Rate

There are two main systems used to determine a currency's exchange rate: floating currency and pegged currency.

The market determines a floating exchange rate. In other words, a currency is worth whatever buyers are willing to pay for it. This is determined by supply and demand, which is in turn driven by foreign investment, import/export ratios, inflation, and a host of other economic factors.

Generally, countries with mature, stable economic markets will use a floating system. Virtually every major nation uses this system, including the U.S., Canada and Great Britain. Floating exchange rates are considered more efficient, because the market will automatically correct the rate to reflect inflation and other economic forces.

The floating system isn't perfect, though. If a country's economy suffers from instability, a floating system will discourage investment. Investors could fall victim to wild swings in the exchange rates, as well as disastrous inflation.

Find a Floating System
You can see a floating system at work. Changes in the U.S. and Canadian economies have led to the Canadian dollar becoming worth more. For years, a Canadian dollar was worth about 65 cents. In 2003, it rose to 75 cents. By early 2007, it had reached about 92 cents. Look in the business section of your newspaper, or check an exchange rate calculator on the Internet, and track the Canadian dollar's rise in value yourself. Right now, economists aren't sure how high it will go.