eli5 How can Iraq decide their currency value when other currencies are based on Forex market? Additionally what stops them from making the currency super valuable?
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What you are referring to is “pegging” the currency. The value of the currency is defined according to some reference such as a different currency or measure of value.
Supply, demand, and the foreign exchange market don’t just vanish as you recognized. In order to maintain this pegged value the government of the currency must “defend the peg” by buying and selling its own currency on the open market, often maintaining foreign currency reserves.
For example if the Iraqi government wants to peg the dinar at 1450 to 1 USD then regardless of if the market at large thinks a dinar should be worth say 1200 to 1 USD, the Iraqi government will give you 1450 dinar for 1 USD and vice versa. They need to buy their own dinar and USD in order to do that though, at whatever the current forex rate is.
This should reveal the issue with pegging their currency as extremely valuable. If tomorrow they pegged the dinar as equal to the USD then when someone gives them dinar they would need to pony up USD equal to that amount. Chances are they will be the only entity willing to make that trade and getting the USD will involve massive losses.
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