By Kristina Zucchi, CFA
From the end of World War II until around 1971, most currencies were in some form pegged (or fixed) to the U.S. dollar, which was itself fixed to gold. Beginning in the early 1970s when the Bretton Woods Fixed Exchange System collapsed, governments began floating their own currencies. Today, though, two types of currency exchange rates—floating and fixed, are still in existence. Major currencies, such as the Japanese yen, euro, and the U.S. dollar, are floating currencies—their values change according to how the currency is being traded on forex markets. Fixed currencies, on the other hand, derive value by being fixed (or pegged) to another currency. In this article, we will discuss exchange rates that continue to peg to the U.S. dollar.
When countries participate in international trade, they need to ensure that the value of their currency remains relatively stable. Countries choose to peg their currency to safeguard the competitiveness of their exported goods and services. A weaker currency is good for exports and tourists, as everything becomes cheaper to purchase. By pegging to the currency used by primary trade partners or to a standard or major currency, countries can ensure their goods and services remain competitive and are not impacted by the constant fluctuation of a floating currency’s exchange rate. Many, though, chose to maintain a fixed policy and today there are still a significant number of currencies pegged to the U.S. dollar. (See more A Primer on Currency Regimes)
Why Currencies Peg to the U.S. Dollar
Countries have different reasons for pegging to the dollar. Most of the Caribbean islands (Aruba, Bahamas, Barbados, and Bermuda, to name a few), peg to the U.S. dollar because their main source of income is derived from tourism paid in dollars. Fixing to the U.S. dollar stabilizes the economies and makes them less volatile. In Africa, many countries peg to the euro. Dijibouti and Eritrea, pegged to the U.S. dollar, are the exceptions. In the Middle East, may countries (including Jordan, Oman, Qatar, Saudi Arabia, and United Arab Emirates) peg to the U.S. dollar for the stability—the oil-rich nations need the United States as a major trading partner for oil. In Asia, Macau and Hong Kong fix to the U.S. dollar. China, on the other hand, has been embroiled in controversy about its currency policy. While it does not officially peg its currency, the Chinese yuan, to the U.S. dollar, it does manage it (some say manipulate it) to benefit its manufacturing and export-driven economy.
Source : investopedia
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