Why peg currency to dollar

When this happens, it is known as a broken peg and the inability of a country to defend its currency from the broken peg can rapidly lead to devaluation of the currency and severe disruption to the local economy. There are a number of reasons why countries prefer to peg their currency to another.

These reasons include enhanced stability for the pegged currency, increased trade and an increase in real income and profits for businesses. When exchange risk is removed from the economic equation both the pegging country and the country whose currency is used for the peg can benefit from enhanced specialization, trade, and exchange.

Long-term investing also becomes more beneficial when a currency peg removes the threat of instability and economic disruptions. This means keeping adequate foreign currency reserves to counter any excessive buying or selling of the currency.

Problems can also arise if the currency is pegged at a rate that is too low or too high. In the former case we see consumer purchasing power eroded, as well as trade tensions between the country with the artificially low exchange rate and its trade partners. In the latter case it may become increasingly difficult to defend the peg as excessive consumer spending will create trade deficits that create downward pressures on the pegged currency.

This forces the central bank to spend foreign reserves to defend the peg and eventually these foreign reserves are exhausted, leading to a broken peg. Still don't have an Account? Sign Up Now. What is Currency Peg? What is Scalping? What is Arbitrage? What is Liquidity? This can be difficult in times when the dollar gets too strong, and in parrallel, your home currency is getting hit on the near term. Riham Darwish. Most world countries have pegged their own local currencies to the US dollar for decades.

Subscribe Sign up to our newsletter for exclusive updates and enhanced content. Subscribe Now. Eventually, the BoT had to abandon the peg on July 2, Employees of suspended finance companies during a rally outside the Bank of Thailand in Bangkok on November Hundreds of disgruntled employees who were either laid off or about to lose their jobs urged the central bank to take responsibility for their plight. Operations in 58 of the country's 91 finance companies were suspended. The depreciation of the baht was followed by a chain reaction of people speculating against other Southeast Asian currencies, including the Malaysian ringgit, the Philippine peso, and the Indonesian rupiah.

And then, in , it spilled into Russia and Brazil. In , prices in Argentina were rising so quickly that supermarkets didn't even bother to update price tags. Instead, they just read out the prices over intercoms, according to Reuters. That's how insane Argentina's hyperinflation was from in the late s to the early s. Argentines took to the streets to protest the soaring prices. In Buenos Aires, "bands of angry youths, armed with sticks, steel bars and in some cases firearms, roamed poor neighborhoods burning tires, battling the police and looting food stores," reported James Brooke in The New York Times on May 31, Trading Economics.

Domingo Cavallo was the guy who had to try to solve this. As minister of the economy in , he came up with a plan known as "Covertibilidad" — or "convertibility. But, eventually, Argentina ended up running into the negative effects of having a fixed-exchange rate. Unemployed Argentines demand food at the gate of a supermarket on the outskirts of Buenos Aires on December 19, Police in riot gear fired tear gas and rubber bullets to disperse looters who ransacked shops and supermarkets in the capital and northern part of the country, in some of the worst rioting in more than a decade.

This was evident when the Asian financial crisis bled into Brazil, and the Brazilian real plunged. The peso, still linked to the dollar, did not. This left Argentine exports significantly more expensive relative to those of Brazil, taking a toll on Argentina's economy and making it harder for the government to repay its debts. And "a decline in world prices for farm product, and the global economic slowdown of recent months, only worsened Argentina's problems. Although one might think that devaluing the currency would solve the export problem, Argentina's other issues made this a difficult choice.

As The Economist explained in June :. Less than a tenth of the government's debt is denominated in pesos, so devaluation would bring financial ruin to it as well as to private-sector borrowers. But the shadow of a potentially catastrophic default still hangs over Argentina. Your Practice. Popular Courses. Table of Contents Expand.

What Does Pegging Mean? Why Peg to the U. Major Fixed Currencies. The Bottom Line. Key Takeaways There are two types of currency exchange rates—floating and fixed.

The U. Fixed currencies derive value by being fixed or pegged to another currency. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

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Dollar Became the World's Reserve Currency.