Bitcoin Forum

how does currency pegging work? how can this even work?

Saudi arabia and the UNited States are worlds apart. Does this work because of the dependance on their oil?

A peg works when a central bank has enough of the foreign currency that they can credibly offer to exchange to and from the local currency at a fixed ratio.  Since the US Dollar is a huge major reserve currency around the world, most foreign central banks, particularly in countries that export to us, are able to do this, if they choose to.

Why they would want to do so is a more difficult question.

can you clarify on the "enough" part? how much?

See: WWII

for a peg to work... do they 2 currencies need to have dependencies on each other?

It would be tough to put a number on that, but in general he means enough to maintain the peg. That means they have to able to sell USD to buy their domestic currency (which reduces the supply of the domestic currency and causes the value to increase), or buy USD using their domestic currency (which increases the supply of domestic currency and causes the value to go down). How much is that? Who knows. Depends how aggressively the market is trying to move the price of your currency I suppose.

Sometimes this gets messed up by whoever is running the show. That was one of the issues (among many I'm not going to type out right now) in the Asian currency crisis in 97. The central banks of a bunch of Asian countries ran out of the currency reserves they where using to maintain their exchange rates at a certain level, and everything crashed when they couldn't support the price anymore.


As for why countries do it is to tie their monetary policy decisions to the country they are pegging their currency to. When you peg to the USD for example you no longer have to make decisions about the size of your money supply, or interest rates or anything like that as long as you maintain your pegged value.

Or maybe they're just lazy.

All currencies have dependencies on each other.


edit: Exchange rates are all about relative supply and demand for the 2 currencies you are looking at, so they have nothing but dependency on each other when you get right down to it.

There is an exchange rate between apples and lamps. I wouldn't say they have a dependency on each other.

let's say you wanted to peg the bitcoin to the dollar.  you just place huge bid offers at $0.99 and huge sell offers at $1.01

*note*  you may want to use other people's money to do this, since it's pretty dumb.

You could do this on MtGox. Be sure to use dark pool bids, so that you can bluff how big your orders are: another thing that goverments and central banks are good at. Bluff that everything is OK right until the moment everything goes down the drain in 5 minutes. Then still call it a succesful policy and blame other people for breaking it.

Enough means, well, enough.  If you run out, it is bad and the peg is broken.

But, if you control your local currency, and are a net exporter to the US, you can run it until political pressure forces you to stop doing it.

Consider China.  They control their national currency, so they can always buy dollars and sell Renminbi, because they can create Renminbi out of thin air.  They can also sell dollars and buy Renminbi, because as a net exporter to the US, they always have more dollars coming in than they need.

For an overview of how a currency peg works in practice, see this article.  http://www.marketskeptics.com/2009/01/hyperinflation-will-begin-in-china-and.html (http://www.marketskeptics.com/2009/01/hyperinflation-will-begin-in-china-and.html)

I'm not sure about the conclusions they draw, but the first diagram is worth a thousand words in understanding how it all fits together.

I think you meant "See Petrodollar".

can pegging work without holding reserves of the currency you are pegged to?

is this frowned upon or illegal?...... how does United States of America view other countires pegging to their currency?

Sorta, but not really.  I mean a country could probably get away with it for a while, maybe even a long time, if they are able to swap whatever reserves they have for their peg target.  But that makes them more vulnerable to swings in forex rates.

It is sorta frowned upon, sometimes.  Our politicians call China a currency manipulator, and claim to be unhappy about it, but nothing comes of it.

WWII saw the opening of the Bretton Woods era in the world economy.  Where governments started to keep US dollars as reserve in place of gold or silver.  They trusted that the US wouldn't inflate it's currency (Hahahahha).  Richard Nixon put an end to that in the 70ies and we started to see massive inflation until the fed jumped the interest rates into the double digits.  We've been in a quasi bretton woods economy ever since, with some countries pegging to the US dollar.  Less and less as we go on because of the weakening dollar fewer countries want to peg their currencies to it.

Erm.  I'm not sure the part about the dwindling number of pegged currencies is true, but I'm too tired to do the research tonight.  Nixon closing the international gold window certainly did happen, but it was probably caused by, rather than causing, inflation.

Currencies are highly fungible.  The dollar is shitty, but it still beats all of the alternatives.  Any country could swap their dollars for any other currency, more or less at any time.  So we must come to the conclusion that countries keep (and accumulate!) dollars as reserves because they prefer it.

Yep he stopped the gold standard because of inflation and he knew investors would start raping the US' stores of gold in exchange for dollars which would have crashed.  So he decided to let it float, inflation exploded after that but maybe not as much as it would have if the foreign investors cashed out.

Fixed that for ya.  The closing of the gold window was Nixon's solution to the Triffin dilemma (http://en.wikipedia.org/wiki/Triffin_dilemma).  Well, maybe not solution exactly, but at least an attempt.

The era after the close of the international gold window is known as Bretton Woods II, or the Washington Consensus.