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Why currency pegs fracture


May 12, 2022

A stablecoin called TerraUSD (UST) imploded today, triggering billions of dollars in losses and raising the concern of why any cryptocurrency– or perhaps a government-issued fiat currency, for that matter– would ever wish to have its worth pegged to some other currency.

Why it matters: Nowadays, the majority of currencies drift easily versus each other. Historically, nevertheless, that’s something of an abnormality. Undoubtedly, as just recently as 1971, even the U.S. became part of the Bretton Woods system that pegged all currencies to a gold requirement.

The huge photo: Pegs get presented when market forces produce a level of volatility that makes preparation and market unnecessarily hard.

  • Nations execute pegs to make sure steady rates, both for their residents and for any markets that export or import products. Certainty and predictability are advantages.
  • Then, if the peg wind up too far from basics, it can end up being hazardous and fragile, and ultimately break. When it comes to UST, there were no basics, so it was susceptible to break at any time. In the end, UST lasted less than 20 months.

A peg that’s stood the test of time: The Hong Kong dollar damaged considerably in the summertime of 1983, triggering panic offering of the currency, and panic purchasing of grocery store products.

Data: FactSet; Chart: Axios Visuals
Information: FactSet; Chart: Axios Visuals

The option: The regional currency was pegged to the U.S. dollar at a rate of 7.8 to 1 on Oct. 13 of that year. It’s remained at that level since– more than 14,000 days and counting. (Because 2005, the currency exchange rate has actually been permitted to change within a narrow band, from 7.75 to 7.85.)

How it works: The Hong Kong Monetary Authority (HKMA) has a $466 billion Exchange Fund, which it utilizes to purchase unrestricted Hong Kong dollars at the 7.85 level. On the other hand, the HKMA will offer unrestricted Hong Kong dollars at 7.75.

  • The dollar peg ways that the HKMA can’t set its own financial policy. Whatever rates of interest the Fed sets is perforce the over night rates of interest in Hong Kong, too.

The bottom line: It’s extremely unlikely that monetary speculators might break the Hong Kong peg. China’s management, on the other hand, might do so at any time, if Sino-American relations weaken even more.

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