Understanding Currency Pegs: Benefits, Examples, and Global Impact

What Is a Currency Peg?

A currency peg is a policy by which a national government or central bank sets a fixed exchange rate for its currency according to a foreign currency or a basket of currencies. The peg stabilizes the exchange rate between countries because it reduces uncertainty, promotes trade, and boost economies. Some countries peg their currencies to stronger economies to expand markets and minimize risks. As of 2024, 12 countries pegged their currencies to the U.S. dollar.1

Advantages of Currency Pegs

Currency pegs reduce foreign exchange risk, encouraging trade. They allow countries to align with stronger economies, helping domestic companies to access larger markets safely.

Some currencies float with market supply and demand, while others are pegged at fixed rates to other currencies. Pegging provides long-term predictability of exchange rates for business planning and helps to promote economic stability.

Historically, the U.S. dollar, the euro, and gold have been popular choices. Currency pegs create stability between trading partners and can remain in place for decades.

List of Currencies Pegged to the U.S. Dollar

As of 2024, 23 currencies were pegged to the U.S. dollar:1

• Aruban florin
• Bahamian dollar
• Bahraini dinar
• Barbadian dollar
• Belize dollar
• Bermudian dollar
• Cayman Islands dollar
• Cuban Convertible Peso
• Djiboutian franc
• East Caribbean dollar
• Salvadoran colon
• Eritrean nakfa
• Hong Kong dollar
• Jordanian dinar
• Kuwaiti dinar
• Lebanese pound
• Antillean guilder
• Omani rial
• Panamanian Balboa
• Qatari riyal
• Saudi riyal
• United Arab Emirates Dirham
• Venezuelan bolívar

Pros and Cons of Currency Pegging

Pegged currencies boost trade and real income, especially when currency fluctuations are low and stable. Without exchange rate risk and tariffs, individuals, businesses, and nations benefit fully from specialization and exchange. Central banks must monitor and manage cash flow and avoid spikes in a currency’s supply and demand when pegs are in place.

Central banks often hold large foreign exchange reserves to manage excessive currency buying or selling. Currency pegs affect forex trading by artificially stemming volatility. When a currency is pegged at a low exchange rate, domestic consumers will be deprived of the purchasing power to buy foreign goods. If a currency is pegged at a high rate, a country may be unable to defend the peg over time.

High import demand can lead to trade deficits, pressuring the home currency. This forces governments to use foreign reserves to maintain the peg. If government reserves are exhausted, the peg will collapse.

Real-World Example: Saudi Riyal Peg to the USD

Since 1986, the Saudi riyal has been pegged to the USD.2 The Arab oil embargo of 1973, Saudi Arabia’s response to the United State’s involvement in the Arab-Israeli war, precipitated events that led to the currency peg. The embargo devalued the U.S. Dollar and led to economic turmoil.

The Nixon administration drafted a deal with the Saudi government to restore the USD to the super currency it once was. From this arrangement, the Saudi government enjoyed the use of U.S. military resources, an abundance of U.S. Treasury savings, and a booming economy saturated with the USD. The riyal was supported by Special Drawing Rights (SDR), an international reserve asset created by the International Monetary Fund to supplement the official reserves of its member countries with freely usable currencies of IMF members.

Due to high inflation and the 1979 Energy Crisis, the riyal suffered a devaluation, leading the Saudi government to peg the riyal to the US Dollar. The Saudi Arabian Monetary Authority (SAMA) credits the peg for supporting economic growth in its country and for stabilizing the cost of foreign trade.3

The Bottom Line

A currency peg is a strategy whereby a country’s central bank or government sets a fixed exchange rate with a foreign currency or a basket of currencies. A peg’s benefits include reducing foreign exchange risk and volatility, encouraging international trade, and promoting economic stability. The potential drawbacks of a peg strategy, especially if badly managed, include the risk of creating trade deficits and affecting purchasing power. Central banks hold large foreign exchange reserves to defend a currency peg. One example of a peg: the Saudi riyal has been pegged to the U.S. dollar since 1986.