Adjustable Peg (FOREX) - Explained
What is an Adjustable Peg?
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Table of ContentsWhat is an Adjustable Peg?How Does an Adjustable Peg Work?Example of a Currency PegAcademics Research on Adjustable Peg
What is an Adjustable Peg?
Adjustable peg is a foreign-exchange rate policy in which the domestic currency is measured in terms of standard currency such as U.S. dollar, but can be regulated as per the dynamic market scenario. Such flexible adjustments increase a company's potential in trade, especially in terms of export business.
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How Does an Adjustable Peg Work?
Generally, an adjustable peg offers 2% flexibility as opposed to a given rate. In case, the exchange rate tends to go beyond 2%, the country's central bank comes into picture in order to keep the exchange rate fixed. The essence of adjustable peg system lies in the country's potential to re-evaluate its peg for getting a competitive edge. This term was devised during the United Nations Monetary and Financial Conference in 1944. As this conference took place in Bretton Woods, the agreement was named Bretton Woods Agreement in which different currencies were fixed in terms of gold price, and U.S. dollar was considered to be the reserve currency that was associated with the gold price. After this agreement, majority of the Western European countries resulted in pegging currencies to U.S. dollar. However, this agreement was dismissed between 1968 and 1973 when the U.S. dollar was valued beyond the set limits, thereby messing up with exchange rate and gold price levels. President Richard Nixon announced an interim dismissal of dollars convertibility policy. And, the nations could select exchange agreements based on their preference, excluding the gold price.
Example of a Currency Peg
If we had to take an example of a currency peg that mutually benefited both currencies, it would be that of Yuan (Chinas currency) and U.S. dollar. In December 2015, China disassociated with U.S. dollar, and in turn, switched to 13 different currencies. However, in January 2016, it sought a quick switch again. China, being an exporter, has an upper hand in foreign markets. Owing to its weak currency, its exports are cheaper as compared to those of competitors. Being the biggest exporter for U.S., China pegs its local currency (Yuan) to U.S. dollar. Also, several businesses in the U.S. get benefited from Chinas weak currency and consistent exchange rate. This consistency lets businesses develop long-run strategies knowing that currency fluctuations wont have any impact on the costs related to development and investment in imports. A drawback of a pegged currency can be the fact that it is maintained at an artificially lower rate, that suppresses competition in comparison to a floating exchange rate. Several local manufacturers in the United States believe that products that are priced lower, due to artificial exchange rate policy, drastically affect job opportunities in the U.S.