Currency exchange is just like any other transaction, right? Someone wants to buy dollars with Euros, someone else wants the inverse, and they trade. How would a government manage to effectively regulate all of that, when those transactions are happening all over the world?
In: Economics
The government can make a standing offer to buy and sell at a specific rate. If it has enough liquid assets to back up that offer, it can make it stick.
When the price goes too low, they buy it. When the price goes too high, they sell it. It takes a lot of money to do this, but if you’re motivated, you can do it for a range of trading values.
An example of this is Hong Kong. They keep large reserves of HKD and USD on hand so they can buy/sell whenever the ratio between the two drifts too far from their desired peg.
You also have to consider that pegging currencies can be very easy or very hard depending on what the currencies are. If one country depends massively on another one (or on another one’s currency) for its economy, then keeping the currencies pegged will be very easy because it is highly unlikely that there will be a large demand or supply imbalance between the two currencies.
An example of an “easy” peg is the UAE dirham being pegged to the USD – the UAE economy depends on oil exports and oil is typically priced in dollars, so even without a peg you would expect an extremely strong correlation between the two currencies.
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