Countries use an agreed-upon currency worth a specific measure standard. On the other hand, the unregulated forces of supply and demand determine the floating exchange rate system. "During this, there is a trade-off between the rate of inflation and the current account"(Corden 86). "If a country imports large quantities or goods, the demand will push up the exports imports large quantities of good, the demand will push up the exchange rate for that country, making the imported goods more expensive to buyers in that country. As the goods become more expensive, demand drops, and that country's money becomes cheaper in relation to other countries" money"(Gwinn 627). From 1870 to 1914, the exchange rate was determined by the Gold Standard. This system was a fixed exchange rate, and the way it worked was by pricing every currency in terms of gold. So in general terms, if X amount of one currency was equal to one ounce of gold, and Y amount of currency was also equal to one ounce of gold, then X and Y can also be exchanged. But this system had many flaws that led to a new system after all those years. The main problem with the gold standard arose due to the fact that the money supplied depended a great deal on the amount of gold held in banks, but the countries had little control over the money supply. If the demand for a currency exceeded the actual supply, banks were forced to ship gold to satisfy the individual country's requirements for the scarce currency. A flow of gold into a country obviously increased the money supply, which in turn raised prices and made its goods more expensive. This, in turn, reduced foreign demand for its currency. Then an example of how this relates to exchange rates is that if the total demand for a certain currency is decreased, the value of the currency also decrease. So more of it has to be exchanged for another currency to be equal in value. So because of this problem, the gold standard was replaced by a new monetary system.
