Managed Float Regime

The current worldwide financial environment is called a managed (or dirty) float regime. With national and regional economies increasingly intertwined, currencies are almost universally managed by central authorities: While exchange rates fluctuate daily, central banks or other institutions buy and sell currencies in order to influence their value. This intervention works, in part, to slow down the damage that can be done by economic crises in the international economy.

The managed modifier is used to highlight the difference between this circumstance and a “pure” floating exchange rate, one in which those fluctuations are governed by market forces. The dirty float regime is one in which currencies are allowed to fluctuate—they are not pegged to fixed values as in fixed exchange rate systems—but intervention manipulates those fluctuations, like the paddle in a boat at sea, still bobbing with the waves rather than being affixed to a pylon, but (ideally) never capsizing or pulled too far in one direction or another.

The foreign exchange market, currency speculators, and arbitrageurs all amplify the size and frequency of currency fluctuations, and central bank intervention is meant to counteract that. More than three quarters of the activity on the foreign exchange market is speculative, purchases made with no intention of “spending” that currency. This has been increasingly true since the late 1990s, when currency speculation started to become more and more intense, more and more aggressive. When speculators short huge amounts of a country's currency, the government can buy it back in order to stabilize prices and prevent a plummet—essentially acting as a force to countermand the already artificial nature and very real effects of currency speculation and the treatment of money as a commodity good.

Compared to private entities, central banks have tremendous foreign exchange reserves, and use various strategies to try to stabilize the market, influence inflation or interest rates, and constrict or enlarge the money supply. There is often a target rate for their currency—not as fixed as a pegged rate, but a range to shoot for. Economist Milton Friedman has advocated applying the buy low/sell high strategy to the managed float: Central banks should buy up their currencies when they are exchanging at too low a rate, and sell them when the rate is too high, thus not only stabilizing the currency market but making a profit. To date, central banks' activities have been more reactive than this, and so there is too little real-world data to evaluate the effectiveness of Friedman's strategy.

Typically, intervention occurs not with every jot and jostle of the market, but a few times a year in [Page 1050]order to right the course. It is not always enough, but the severity of currency-related crises like the Asian financial crisis of the late 1990s is enough to demonstrate the need for action of some kind.