What Is Currency Pegging?

Currency pegging means tying a nation's currency exchange rate to that of another nation. This policy is intended to provide stability to a nation's currency and its economy by linking it to an already stable currency. Pegging often includes preset ratios, which is why a pegged currency may be called a fixed rate.

The U.S. dollar is used as a currency peg by many nations, as it is the world's 澳洲幸运5官方开奖结果体彩网:reserve currency.

(In a different usage, pegging refers to the practice of mani🐎pulating the price of an underlying asset, such as a commodity, prior to the expiration of an options contract.)

Understanding Pegging

Wide currency fluctuations can do severe damage to international business transactions, which is why many countries maintain a currency peg. Keeping their currencies stable removes a barrier to ๊trade.

Pegging to the U.S. dollar is common. The currencies of more than 66 countries are pegged to the U.S. dollar, according to AvaTrade.

Why Peg a Currency?

澳洲幸运5官方开奖结果体彩网:Currency risk is an issue for any company that imports or exports goods. For example, if a U.S. company operates in Brazil, the firm has to convert U.S. dollars into 澳洲幸运5官方开奖结果体彩网:Brazilian reals (BRL) to fund its Brazilian business. If the value of Brazil’s curren🌃cy changes dramatically compared to the dollar, the U.S༒. company may incur a loss when it converts back into U.S. dollars.

Thus, a nation that pegs its cu🦩rrency has an edge over the competition for international trade.

Exchange rates between pegged currencies are not necessarily 1/1. For instance, the fixed rate for a U.S. dollar is 3.67 澳洲幸运5官方开奖结果体彩网:United Arab Emirates dirham (AED).

A country's 澳洲幸运5官方开奖结果体彩网:central bank goes into the open market to buy and sཧell its currency to maintain the pegged ratio that has been deemed optimal.

Advantages and Disadvantages of Pegging

There are benefits and drawbacks for a nation to consider when deciding whether to peg its currency.

Advantages

Pegged currencies can expand trade opportunities and boost the real incomes of its citize🍃ns, keeping currency fluctuations relatively low. Individuals, businesses, and nations are free to benefit more fully from specialization and sell their goods in other countries without the associated exchange rate risk.

According to the theory of comparative advantage, everyone will be able to spend more time doing what they do best. Farmers can concentrate on their crops rather than spending time and money hedging foreign exchange risk with 澳洲幸运5官方开奖结果体彩网:derivatives. Teꦅchnology firms can focus on building better computers.

Perhaps most importantly, retailers in both countries can source from the most efficient producers. Pegged exchange rates make more long-term investments possible in the other country. With a currency peg, fluctuating exchange rates are not constantly disrupting 澳洲幸运5官方开奖结果体彩网:supply chains and changing the value of investments.

Disadvantages

Countries can experience problems when a currency is pegged at low exchange rates. Domestic consumers are deprived of their 澳洲幸运5官方开奖结果体彩网:purchasing power to buy foreign goods.

For example, the 澳洲幸运5官方开奖结果体彩网:Chinese yuan is pegged against a basket of foreign currencies. If its peg is too low against the U.S. dollar, Chinese consumers will have to pay more for imported food and oil, lowering their consumption levels and their♊ standard of living. At the same time, U.S. farmers and Middle East oil producers will lose business. This situation naturally creates traꦐde tensions.

Other problems emerge when a currency is pegged at an overly high rate. A country may be unable to defend the peg over time. Domestic consumers will buy too many imports and consume more than they can produce. These chronic 澳洲幸运5官方开奖结果体彩网:trade deficits will create downward pressure on the home currency, and the go💎vernment will have to spend foreign exchange reserves to𓆉 defend the peg. The government's reserves will eventually be exhausted, and the peg will collapse.

When a currency peg collapses, the country that set its peg too high will suddenly find imports more expensive. That will cause 澳洲幸运5官方开奖结果体彩网:inflation to rise, and the nation may have difficulty paying its debts. The other country will find its expo𒅌rters losing markets, and its investors losing money on foreign assets that are n♐o longer worth as much in domestic currency.

Why Peg to the U.S. Dollar?

When a country pegs its currency to the dollar, it fixes the exchange at a set, predetermined rate. The value of the currency is maintained by the country's central bank.

Since the U.S. dollar's value is on a 澳洲幸运5官方开奖结果体彩网:floating rate, 🦂it fluctuates. This means that the pegged currency's value rises and drops with the dollar.

Countries that peg their currency to the dollar do so because the U.S. dollar is relatively strong and relatively stable in the international market. As the world's reserve currency, 澳洲幸运5官方开奖结果体彩网:international trade often is paid in U.S. dollars. This helps k๊eep a country's pegged 🌠currency stable.

Some countries peg to the dollar because it helps keep their currencies and, therefore, their exports priced competitively. Others. such as Singapore and Malaysia, do so because their economies are particularly reliant on trade.

Currencies Pegged to the Dollar

At least 66 nations have tied thꦰeir currenci𒅌es to the U.S. dollar.

Aside from the dollar's stability, some nations have additional reasons related to their economic strengths. For example, many Caribbean island nations including Aruba, Barbados, and Bermuda, rely on American tourists who are paying in dollars.

Here are some of the notable countries whose currencies are pegged to the greenback along with thei♔r rates:

• Belize dollar (BZ$): 2.00
• Cuba convertible peso (CUC): 1.000
• Hong Kong dollar (HKD): 7.76
• Panama balboa (PAB): 1.000
• Saudi Arabia riyal (SAR): 3.75
• United Arab Emirates dirham (AED): 3.673
  

The Bottom Line

Nations that peg their currency generally do🀅 so as a way to open up trade opportunities with other nations. It makes 🃏them more attractive to foreign investment as it greatly reduces currency risk as a factor.

Nevertheless, the strategy has its risks. A nation has to set the ratio correctly, and keep defending its value, or risk se♏rious economic effects at home.