As usual, I’ll keep it simple. I won’t get into too much details.
First of all, currency peg means fixing the exchange rate of one currency against the other (contrast with floating exchange rates). For example, the Malaysian Ringgit (MYR) was pegged with the US Dollars (USD) at 3.800, after the Asian financial crisis.
So, how is a currency pegged?
If one country decides to peg its currency against another currency, the government will be the major player in this. The government will be the one buying or selling its own currency in the market to manipulate the rates.
Here’s how it works.
If the exchange rate is depreciating below the desired rate, it will buy its own currency in the market, to drive the rates up again.
If the exchange rate is appreciating above the desired rate, it will sell its own currency, pressuring it to go down again.
This is how currency pegs are usually maintained. It’s all supply and demand baby!
Another way is for the governments to make it illegal for its currencies to be traded against the pegged currency, at other than the desired rate levels. China did this once.
So there you go, a basic explanation of how currencies are pegged.
Disclaimer: This article is not a specific nor general advice on managing or investing your money. This article does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.
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