I’m currently in Belize, where the local currency (the Belize Dollar) is “pegged” to the US dollar, with 1 Belize Dollar always being worth $0.50 USD. I also heard that the Guatemalan Quetzal was pegged to the dollar in the 20th century, but isn’t any more.
How does this work? Does this mean that Belize Dollars are functionally US dollars in the global economy? And there must be implications for how much money a pegged country could print without losing its value…I could use an overview!
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There’s three main ways:
– Having enough of that currency to exchange (as others have said), much like a gold standard. This works great if you can afford to buy enough currency for the currency you’re pegging to.
– Manipulating the price on the market to keep it roughly in line. This involves adjusting your interest rates plus buying and selling currency to keep it in line. So long as everyone thinks the peg will work, this works okay. Once the markets get a whiff that it’s going to collapse, they “bet” that the currency peg will fail by buying or selling your currency, the peg most likely falls apart, and your central bank is out a lot of money. This happened to the UK when it crashed out of the ERM.
– Declaring it to be so and the arresting anyone in the country who does otherwise. This one doesn’t work, generates a huge black market, and basically means one of the currencies stops being used. Still, some countries do try it.
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