Currency peg

When a country tries to keep its currency trading at a certain exchange rate, or within a tight range against another currency, this is known as a “currency peg”.

When a country tries to keep its currency trading at a certain exchange rate, or within a tight range against another currency, this is known as a "currency peg". In most cases, currencies are pegged to the US dollar. In the case of China, pegging its currency (the yuan, or renminbi) to the dollar worked out pretty well. In 1994, China fixed the yuan to the dollar at a rate of around 8.28 (representing a significant devaluation at the time).

Advertisement - Article continues below

It remained around this level until 2005, when it moved to pegging the renminbi to a "basket of currencies" that included the euro and the yen. Within a few years, the renminbi had strengthened against the dollar somewhat, although the authorities continued to exert a tight grip.

Maintaining the peg meant that China's exports remained very cheap, driving large trade surpluses with the US (and the rest of the world), and helping to create rapid GDP growth in China. However, as with most attempts to control or suppress markets, it had significant unintended consequences.

In order to keep the renminbi artificially weak, China effectively had to print money to sell in exchange for dollars and other currencies. That in turn caused massive growth in the domestic money supply, which meant that credit was far too readily available, which has resulted in China having far too much debt relative to GDP.

Meanwhile, as growth has slowed, and its current-account surplus (whereby a country exports more than it imports and gets more money from abroad than it sends out) shrinks, or even becomes a deficit, China's exchange rate may no longer be undervalued indeed, it may be overvalued.

This could force China to drop the peg altogether and allow the renminbi to "free float", finding its own level. That would have a hugely disruptive impact on both the global economy and financial markets.




Real exchange rate

The real exchange rate between two currencies combines the nominal exchange rate with the ratio of the price of goods or services in two different cou…
26 Jun 2020

ESG investing

ESG stands for environmental, social and corporate governance, the areas in which good behaviour is particularly sought.
19 Jun 2020

FAANG stocks

The acronym FAANG refers to Facebook, Amazon, Apple, Netflix and Google (Alphabet) – five American companies that have been among the top-performing s…
12 Jun 2020

Technical analysis

Technical analysts or 'chartists' attempt to predict future share price (or index) movements by looking at past movements.
5 Jun 2020

Most Popular


The end of the bond bull market and the return of inflation

Central bank stimulus, surging post-lockdown demand and the end of the 40-year bond bull market. It all points to inflation, says John Stepek. Here’s …
30 Jun 2020

This chart pattern could be extraordinarily bullish for gold

The mother of all patterns is developing in the gold charts, says Dominic Frisby. And if everything plays out well, gold could hit a price that invest…
1 Jul 2020
Global Economy

How “pent-up demand” could drive a V-shaped economic recovery

“Pent-up demand” is usually a myth. But not this time. The Covid lockdown has created genuine pent-up demand, says Merryn Somerset Webb. That’s now be…
29 Jun 2020