Currency Peg

Loading the player...

What is a 'Currency Peg'

A currency peg is a country or government's exchange-rate policy of attaching, or pegging, the central bank's rate of exchange to another country's currency. Also referred to as a fixed exchange rate or a pegged exchange rate, currency pegs stabilize the exchange rate between countries, which allows for accurate long-term predictability for business planning and can anchor rates at advantageous levels for large importers.

BREAKING DOWN 'Currency Peg'

Countries commonly peg their currencies to the currencies of others, most often the U.S. dollar or the euro. Currency pegs add predictability between trading partners and can remain in place for decades, such as the linkage of the Hong Kong dollar to the U.S. dollar, which has remained steady since 1983; Denmark's peg of the kroner to the euro since 1982 is another notable example.

Currency Peg Example

An example of a mutually beneficial currency peg is China’s linkage of the yuan to the U.S. dollar. The peg has been in place for years, is range-bound and has its detractors as well as supporters. China briefly decoupled from the dollar in December 2015, switching to a basket of 13 currencies, but discreetly switched back in January 2016.

As an exporter, China benefits from a relatively weak currency, which makes its exports less expensive on an absolute basis as well as in comparison to the exports from competing countries. The logic behind China’s peg of the yuan to the dollar is based in large part on the United States being its largest import partner at $410.8 billion in 2015, representing 18% of the country’s exports for the year.

The stable exchange rate and a weak yuan also benefit specific businesses in the United States. For example, stability allows businesses to engage in long-term planning, such as ordering prototypes, setting up manufacturing and importing goods with the knowledge that costs will not be affected by currency fluctuations.

The weak yuan also benefits major importers, such as Walmart Stores, Inc. and Target Corporation. For these and other retailers, the savings resulting from paying for Chinese imports in dollars can have a major impact on the bottom line, considering profit margins in this sector typically run in the low single digits.

Disadvantages of Pegged Currencies

The first disadvantage is pegs which keep currencies artificially low create an anti-competitive trading environment when compared to floating rates. This argument has largely been focused on the peg of the yuan to the dollar by domestic manufacturers stating that low-priced goods, partially due to an artificial exchange rate, are costing jobs in the United States.

The second disadvantage is pegs can minimize currency fluctuations, but growing imbalances between the country pegging the currency and the target country can result in large and problematic moves when pegs are broken. Examples of broken pegs followed by major currency fluctuations include the British pound in 1992, the Russian ruble in 1997 and Argentinean corralito in 2002.

RELATED TERMS
  1. Adjustable Peg

    An exchange rate policy adopted by some countries wherein the ...
  2. Price/Earnings To Growth - PEG ...

    Price/Earnings to Growth (PEG) is a stock's price to earnings ...
  3. International Currency Exchange ...

    The rate at which two currencies in the market can be exchanged. ...
  4. Adjustment

    The use of mechanisms by a central bank to influence a home currency's ...
  5. Soft Currency

    A currency with a value that fluctuates as a result of the country's ...
  6. Revaluation

    A calculated adjustment to a country's official exchange rate ...
Related Articles
  1. Markets

    How Does a Currency Peg Work?

    When a government initiates a currency peg, it pegs its currency’s value to that of another country.
  2. Trading

    The Pros And Cons Of A Pegged Exchange Rate

    A pegged currency can give a country many advantages, but these advantages come at a price.
  3. Trading

    Why Is the Chinese Yuan Pegged?

    Explore China's currency peg, which has helped Asia's largest economy enjoy robust growth and continued prosperity by making the nation's exports cheaper.
  4. Investing

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  5. Trading

    Dollarization Explained

    Find out how fledgling economies can find some stability in their currency and attract foreign investment.
  6. Markets

    Forex Tutorial: Forex History and Market Participants

    Given the global nature of the forex exchange market, it is important to first examine and learn some of the important historical events relating to currencies and currency exchange before entering ...
  7. Investing

    Explaining Fixed Exchange Rates

    A government using a fixed exchange rate has linked the value of its currency to the value of another country’s currency, or the price of gold.
  8. Trading

    How To Use The P/E Ratio And PEG To Tell A Stock's Future

    While the price-to-earnings ratio is commonly used for assessing stock prices, the price/earnings-to-growth ratio offers forecasting advantages that investors need to know.
  9. Trading

    Why Switzerland Scrapped the Euro

    Why did the Swiss scrap its peg to the Euro and what impact will it have globally?
  10. Trading

    Advantages of the PEG Ratio over the P/E Ratio

    Earnings are critical to any company’s future prospects, but other factors are important, too.
RELATED FAQS
  1. How are international exchange rates set?

    International currency exchange rates display how much one unit of a currency can be exchanged for another currency. Currency ... Read Answer >>
  2. When computing the PEG ratio for a stock, how is a company's earnings growth rate ...

    Remember that the price/earnings to growth ratio (PEG ratio) is simply a given stock's price/earnings ratio (P/E ratio) divided ... Read Answer >>
  3. Over what duration should I be examining a given stock's PEG (price to earnings growth) ...

    Learn how the PEG ratio provides an assessment of a stock's current price based on its trailing or projected earnings growth ... Read Answer >>
  4. What metrics are commonly used to evaluate companies in the retail sector?

    Discover three of the most common metrics used to evaluate companies in the retail sector, and find out how each plays an ... Read Answer >>
  5. How do I use the PEG (price to earnings growth) ratio to determine whether a stock ...

    Using the PEG, or price/earnings to growth, ratio provides a better picture of a stock's valuation versus simply relying ... Read Answer >>
  6. Under a pegged exchange rate system which of the following measures can be undertaken ...

    The correct answer is: a) By reducing the level of real interest rates at home, foreign and domestic investors will invest ... Read Answer >>
Hot Definitions
  1. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  2. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  3. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  4. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  5. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  6. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
Trading Center