Definition: When a country pegs its currency to the dollar, this means it intends to control the value of its currency so that it rises and falls as the dollar does. To do this, they have to use a fixed exchange rate. Usually, a country will peg its currency to a certain dollar range. The dollar's value changes to much on a daily basis to do otherwise.
How Does a Dollar Peg Work?
A country's finance minister will monitor his country's currency exchange rate relative to the dollar's value. If the currency falls below a certain range, he will buy dollars -- usually in the form of U.S. Treasuries. This increase the dollar's value so it once again falls within the intended range. If the dollar were to rise above the range, the country would sell its Treasuries to lower the dollar's value back within its targeted range.Why Do Countries Peg Their Currency to the Dollar
However, most countries try to keep the value of their currency lower than the dollar. This gives them a comparative advantage by making their exports to America cheaper. A great example of this is China, which pegs its currency (the yuan) to the dollar to maintain competitive pricing.Other countries, like the oil-exporting nations in the Gulf Cooperation Council, must peg their currency to the dollar because their primary export, oil, is sold in dollars. As the dollar has declined, they've become large owners of dollars in their sovereign wealth funds. These petrodollars are often invested in the U.S. to earn a greater return. In fact, Abu Dhabi invested petrodollars in Citigroup to prevent its bankruptcy in 2008. Countries that do a lot of trading with China or oil-exporting countries will also peg their currency to the dollar to remain competitive with their customer.
Also Known As: exchange rate, fixed rate
Examples:
Many large economies, such as China, Hong Kong, Malaysia and Singapore, peg their currency to the dollar.
