what is pegging 
the term pegging refers to the practice of attaching or tying a currency s exchange rate to another country s currency pegging often involves preset ratios which is why it s called a fixed rate pegs are often put in place to provide stability to a nation s currency by linking it to an already stable currency the u s dollar is often used as a currency peg by many nations as it is the world s reserve currency pegging can also refer to the practice of manipulating the price of an underlying asset such as a commodity prior to option expiry understanding peggingwide currency fluctuations can be quite detrimental to international business transactions which is why many countries maintain a currency peg doing so allows them to keep their currencies relatively stable against that of another country pegging to the u s dollar is common as noted above that s because the dollar is the world s reserve currency in europe the swiss franc was pegged to the euro for the better part of the four year period between 2011 and 2015 though this was done more so to curb the strength of the franc from a persistent inflow of capital 1pegging is also a price manipulation strategy used sometimes by options traders as expiration approaches writers options shorts are most commonly associated with the practice of driving up or down the price of the underlying security in an options contract as the expiry date approaches that s because they have a monetary incentive to ensure that the option expires out of the money otm so the buyer does not exercise the option contract the currencies of over 66 countries are pegged to the u s dollar according to avatrade 2currency peggingcurrency risk makes it difficult for companies to manage their finances to minimize currency risk many countries peg an exchange rate to that of the united states which has a large and stable economy but how does it work countries often choose to peg their currencies to a stable one this allows them to keep their currencies stable while allowing their products and services to remain competitive in the export market exchange rates between pegged currencies are fixed for instance the fixed rate for a single u s dollar is 3 67 united arab emirates dirham aed a country s central bank goes into the open market to buy and sell its currency in order to maintain the pegged ratio that has been deemed to provide optimal stability if a country s currency value experiences large fluctuations it becomes even more difficult for foreign companies to operate and generate a profit for example if a u s company operates in brazil the firm has to convert u s dollars into brazilian reals brl to fund the business if the value of brazil s currency changes dramatically compared to the dollar the u s company may incur a loss when it converts back into u s dollars major currency peg breakdowns include the argentine peso to the u s dollar in 2002 the british pound to the german mark in 1992 and the u s dollar to gold in 1971 advantages and disadvantages of peggingthere are some benefits and drawbacks when it comes to pegging we ve highlighted some of the key pros and cons below pegged currencies can expand trade and boost real incomes particularly when currency fluctuations are relatively low and show no long term changes individuals businesses and nations are free to benefit fully from specialization and exchange without any of the associated exchange rate risk and tariffs according to the theory of comparative advantage everyone will be able to spend more time doing what they do best farmers can use pegged exchange rates to simply produce food as best they can rather than spending time and money hedging foreign exchange risk with derivatives similarly technology firms can focus on building better computers perhaps most importantly retailers in both countries can source from the most efficient producers pegged exchange rates make more long term investments possible in the other country with a currency peg fluctuating exchange rates are not constantly disrupting supply chains and changing the value of investments central banks with a currency peg must monitor supply and demand and manage cash flow to avoid spikes in demand or supply these spikes can cause a currency to stray from its pegged price that means these authorities need to hold large foreign exchange reserves to counter excessive buying or selling of its currency currency pegs affect forex trading by artificially stemming volatility countries experience a particular set of problems when a currency is pegged at low exchange rates domestic consumers are deprived of the purchasing power to buy foreign goods suppose the chinese yuan is pegged too low against the u s dollar chinese consumers will have to pay more for imported food and oil lowering their consumption and standard of living but u s farmers and middle east oil producers who would sell them more goods lose business this situation naturally creates trade tensions between the country with an undervalued currency and the rest of the world more problems emerge when a currency is pegged at an overly high rate a country may be unable to defend the peg over time since governments set rates too high domestic consumers will buy too many imports and consume more than they can produce these chronic trade deficits will create downward pressure on the home currency and the government will have to spend foreign exchange reserves to defend the peg the government s reserves will eventually be exhausted and the peg will collapse 