What the hell does ‘pegging your currency’ mean?

Andrew Pegler – 16 July 2010

No it’s got nothing to do with hanging money out to dry or even laundering it. Please let me explain.

All this babble about China unpegging its currency from the USD may sound like something for the pointy-headed economists to mull over but it’s actually not that hard to grasp.

Exchange rates fluctuate just like the share market, i.e. they’re up and down like Lindsay Lohan. To stop this a country can fix its currency at a specific rate. This is known as pegging. So Wayne could peg the AUD permanently at 75c to the USD if he wanted (he wouldn’t, more on that later). BTW Australia’s dollar was pegged until 1983 when it was “floated”. Apparently that was Bob Hawke’s idea. Just ask Paul Keating.

Pegging works thusly. To lower the value of the AUD the Reserve Bank will sell heaps of it into the market but to increase its value it buys up heaps of it. That’s the timeless law of supply and demand for ya.

Gee sounds like a great idea, so why don’t we all do it?

To keep a rate pegged/fixed the government has to play with interest rates. A lot. And that’s always trouble. If the AUD is in danger of falling, it will raise interest rates to increase demand, which pushes the price back up. And vice versa. The RBA also needs to have mountains of foreign reserves and AUD stashed away to manipulate the rate using the laws of supply and demand.

Now, what’s all this babble about China unpegging the Yuan?

In mid 2008, as the GFC was tonking us all for six, China moved to peg its currency, the Yuan, at around 6.83 to the USD. Many regarded this as too low because it made Chinese exports far cheaper and gave them an unfair trade advantage. Needless to say this ticked off a lot of people so the Chinese are unpegging it. This is good news for us because if the Yuan does increase in value, China can buy more of our dirt. On the flip side, a stronger Yuan will make Chinese exports more expensive and hence lessen demand, which could dampen growth there and clip its need for stuff we produce (as opposed to dig out) like meat, furniture, cars and budgie smugglers. Swings and roundabouts.

And that’s pegging unpegged.

And in other news… The International Monetary Fund has just raised its global economic growth forecast for this year from 4.2% to 4.6%. However, it warns of a possible slowdown thanks to sovereign debt dramas and budget imbalances across the developed world. An all too familiar warning folks.

As always I welcome your feedback and any ideas for subjects I can tackle. So go on, let us know what’s on your mind – log in and post your comments below.