I’ve read that there are a number of foreign countries that have their currency “tied” to the US dollar.
How does that work exactly?
Thanks!
Suppose I am the Bank of Hong Kong and I issue HK$ pegged at HK$7.8=US$1 . I buy and sell at that rate and that keeps the value of the HK$ constant with respect to the USD. Nobody will pay more because they can get it for 7.8 from the bank while nobody will sell for less because they can sell it for 7.8 to the bank.
AFAIK, it means the currency doesn’t ‘float’ on international markets - you can’t buy and sell it from afar. It tends to happen where the local economy is dominated by the larger one…the example I have first-hand experience of is Bermuda…
It’s a British territory, but that doesn’t require it to use British money. The Bermudian dollar is equivalent to the $US, and the latter is accepted without question - at a rough guess, 1/4 to 1/2 of the money was American. They mint their own coins, too - matching US ones in dimensions, but with their own design on the rear, and the Queen on the front. No doubt part of the reason for this compatibility is the use of slot machines of various kinds, coin counter in banks, etc.
The currency of Panama is (or was) called the “balboa.” However, the balboa was never anything but a name, a polite fiction. It’s actually the U.S. dollar. I think I remember hearing that Panama has now decided not to even bother with the fiction and just plain uses U.S. dollars.
JM is right. In Panama there´s no such thing as a balboa. Prices are cited in Balboas, but all money except coins (“fractionary money”) is US dollars.
There are really a wide variety of systems to manage or guide currency exchange rates, a gamut running from free market to absolute state control.
What the OP asked about are “Pegged Rate” systems, where “the country pegs its currency (formally or de facto) at a fixed rate to a major currency or a basket of currencies where the exchange rate fluctuates within a narrow margin of at most ±1 percent around a central rate.” Countries in this category include Aruba, Bahamas, The Bahrain, Barbados, Belize, China, P.R. Mainland, Iran, Iraq, Jordan, Lebanon, Lesotho, Macedonia, FYR, Malaysia, Namibia, Nepal, Oman, Qatar, Saudi Arabia, Swaziland, Syrian Arab Republic, Trinidad & Tobago, Turkmenistan, United Arab Emirates, Bangladesh, Botswana, Fiji, Kuwait, etc.
Two slightly more liberal or flexible systems also fit under the Pegged category, denominated “Pegged Exchange Rates between Horiontal Bands” and “Crawling Pegs”, which give more weight to actual market behavior.
The trick is that superficial analysis (reading gov documents and press releases) doesn’t reveal the real machinations of how a lot of developing countries manage or manipulate their exchange rates. A wide difference between de facto and de jure, which is the SOP for many of these governments in all areas.
Generally pegging involves an agreement between central banks- if somebody wants to be pegged to, say, the dollar, their prime rate must then closely mirror whatever the Fed is offering that week.
There are actually two different things here. One is a peg, where a country arbitrarily sets the exchange rate against the USD. There is no mechanism in place that ensures the currency stays there - look at the Thai Baht pre-1997 Asian crisis.
The other is a currency board system, such as Hong Kong. Under a currency board system, the note issuing banks actually have US dollars on reserve for every Hong Kong dollar in circulation. This is the key difference with the above pegged exchange rate. If Hong Kong banks want to issue more HKDollars, they have to have more USD in reserve. This also means that a country can no longer set the interest rates. Hong Kong has to use the US interest rate even if that is not the most appropriate for their economic situation. If speculators go after the Hong Kong dollar, the note issuing banks have a natural arbitrage. If the speculators really try to kill the HK dollar, the note issuing banks will take in the HKD and give back USD.
It is confusing because both systems are called “peg” systems. However a currency board system and a traditional “peg” system are two different animals. Ask Hong Kong (currency board) and Argentina (peg) about the difference
Good posts above… one further point
In addition to actively buying and selling at the ‘fixed’ exchange rate, central banks can also restrict market movements by imposing exchange controls, which serve to limit transactions in their sovereign currency. These controls can range from requiring banks to report all transactions conducted (to ensure that such transactions are genuine international monetary transfers, rather than speculative trades) to draconian measures such as legislature that makes it illegal to sell their currency short (on pain of hefty fines or removal of banking licence, etc.).
I seem to remember that during the Soviet era, the ruble was not traded, or floated (or something) on international money markets the way normal currencies are, so that the ruble’s exchange rate had no relationship to its actual value. Or something like that. Could anybody explain?
The rubble was officially non-convertible except under special circumstances. The exchange rate was set by the central government at a ridiculously unrealistic level. Soviets could only buy hard currency under special condiitons, such as an officially approved trip outside the USSR, and even then in ridiculously small amounts (I sem to remember that people emigrating permanently were allowed to take out something like $40).
Even non-Soviets could only change back money into hard currency at the end of their stay if they could show official receipts that a) they had brought in at least that amount of hard currency, and b) the rest had been used through official channels (i.e. exchanged legally into rubles, or used at official hard-currency stores). In practice, there were all sorts of ways around this restriction - for one, who keeps bar receipts? and you could blow a lot of money in a hard-currency bar.
When I arrived in September 1989, the oficial rate was 63 kopecks (.63 ruble) to the dollar. To give you an idea of value, a loaf of bread ran 25-30 kopecks, and a monthly university student stipend was 40 rubles, or 50 if you had a certain GPA. The black-market rate fluctuated between, sat, 5-8 rubles/dollar. Then, in October or so, they bumped the tourist exchange rate to 6.3 rubles to the dollar, so we were suddenly rich (not that there was much of anything to do with the money, anyway). Bread still cost 25-30 kopecks, because it was readily available at state-set prices, but if you wanted, say, a kilo of tomatoes, it would cost you 20 rubles, or half of the monthly student stipend, because you would have to buy them on one of the few legal cooperative (i.e. capitalist) markets. Needless to say, students didn’t tend to eat a lot of produce in winter. And the black market rate went to 10-15 rubles/dollar as all semblance of normal everyday goods simply disappeared from the market. Made for some weird phenomena: people would fly up from, say, Azerbaijan to Leningrad with a suitcase full of pomegranantes (mind-blowingly yummy ones, by the way) to sell at the market, because the air ticket cost practically nothing, but pomegranates were nearly worth their weight in gold (or copper, anyway).
Yes, the whole relationship between currency and purchasing power was completely screwed up. If you want more war stories, check out Hedrick Smith’s classic The Russians.
Pegging or exchanging currency can lead to some severe long-term issues, too, and sometimes it can save your hide. Peg your cash to the dollar, and you get a lot of stability.
On the other hand, Germany had a major crisis a while back when they decided to do the politically expedient thing: change Ost-marks with western Marks one-for-one during reunification. This made East Germans feel warm and special and we’re-all-equals, but it had the side effect of destroying whatever competitive advantage their already near-collapse industry had left.
One more thing: as late as 1995 (and I believe this is technically still the case), it was forbidden to take rubles outside of Russia except with special permission. In 1995, I had a domestic flight layover of about negative 2 theoretical hours in Moscow to change my rubles back into dollars.
Since the line to change money was so long that I would have missed my return flight, I had to find a way to ditch the money, so my group took turns holding each others’ places in the Customs line (you have to clear Customs in Russia on the way out as well as on the way in, to make sure you aren’t removing art treasures or uranium or something) so we could blow our extra rubles at the airport gift shop.
The same used to be true in East Germany. An Italian friend who traveled to East Berlin before the Wall came down said he ended up leaving a really huge tip for the waitress at the restaurant where they had dinner before he crossed back to the West. He had to leave by midnight or turn into a pumpkin, and there was a requirement to change a certain amount into East German marks, which you were not allowed to change back into any convertible currency. However, there was almost nothing to spend it on except, say, the complete works of Marx and Engels in German. He’s fluent in German, but decided to perform an act of kindness (both to the waitress and to himself, because who the heck wants to slog through the complete works of Marx and Engels in German?) and just ditch the money at the restaurant.
Isn’t this supposed to be bad for the US, that is, having a third world country like China peg their currency to the US dollar? I never really understood why, can somoen explain it?
It is not the fact that the currency is pegged to the dollar that is thought to be a problem, it is the level at which the currency is pegged. The US would like China to lower the rate of renminbi to the dollar from the current 8 yuan to 1 dollar, to something like 6 or 7 yuan to 1 dollar. This, it is believed, would make Chinese goods more expensive in the US and US goods cheaper in China. This would help lower the US China trade deficit, and help American firms.
It’s still called the balboa. Officially prices are usually cited in balboas. If you ask the price in stores, people will sometimes give it to you in balboas, others will just say dolares. Newspaper ads may give prices in either balboas (B/.) or dollars ($). But yeah, AFAIK a balboa bill has never been printed for general circulation, although there are coins which are exactly the same size as the U.S. equivalents. Balboa himself is on the cuata (quarter).