Unit 5: Exchange Rate Systems
Part 4: Pegged and Crawling Pegged Rate Systems
Pegged rate
systems. Pegged rate systems are those in which
one currency’s value is anchored—or pegged—by
another. The Bretton Woods modified gold standard was a
pegged rate system: all of the world’s currencies
had set exchange rates with the dollar; exchange rates were
only allowed to move within a specified band set before
central bank intervention in the market was required. Although
no global pegged rate “system” is currently
in place, many world currencies still work with implied
or declared exchange pegs.
For
example the Chinese Yuan, much to everyone’s dismay
(see Unit 2), is currently pegged to the dollar. Before
the Asian financial crisis, the currencies of Indonesia,
Malaysia, and South Korea (among others) were pegged to
the dollar. This helped to exacerbate the crisis in the
region: as the dollar rose in the mid-1990s, these countries’
trade surpluses evaporated, which (among other things) prompted
investors to head for the exits in late 1997.
AUDIO CLIP: This NPR All Things Considered
audio clip, which aired on 8/12/2003, discussed US opinion
of the Chinese Yuan’s pegged value against the US
dollar.
U.S.
companies blast China’s exchange rate policy
Crawling pegged rate systems. Crawling pegged rate
systems are those in which currency pegs are allowed to
change, but slowly. In the 1990s the Mexican peso was assigned
a crawling peg value relative to the dollar. But, as the
Mexican peso crisis of 1994 showed, crawling pegs have the
same weaknesses as stationary pegs: if speculators think
they can make money by making the government defend the
exchange rate, they will; and they usually win in a contest
of financial wills.
In fact, any variation of a pegged exchange rate system
in a nation that allows financial capital to freely flow
in and out is ripe for attack. The reason for this is simple:
if a central bank pegs the value of its currency, unless
it can fully cover that rate—by having enough of the
other nation’s currency to sell—the rate will
only hold so long as market forces agree it is correct.
For example, suppose weakening macroeconomic conditions
in a foreign nation which has its currency pegged to the
dollar encourages Americans invested in that nation to look
elsewhere for higher rates of return. What will happen?
Well, the investors will sell their investments in that
nation and look to its central bank to exchange their funds
back into dollars—and if that nation’s central
bank does not have adequate dollars in reserve, they will
not be able to defend their rate and the value of their
currency will be forced to fall.
