In our last lesson we discussed the main factor which will determine whether or not the US Dollar remains the king of the currency world; its status as the world's reserve currency. In today's lesson we are going to continue this discussion with a look at how countries who peg their currency to the US Dollar have a large affect on whether or not the US Dollar remains the reserve currency of the world.

One of the main reasons why many countries hold so many US Dollars, is so they can use those dollars to fix the value of their currency to the US Dollar. They do this to try and give their currency and economy more credibility, which they hope will lead to a more stable economic environment, and/or to keep the prices of their goods low in comparison to other countries, so their exports will be competitive.

As a quick example lets say that country A pegs their currency at a value of 1 to 1 with the US Dollar. While it is all fine and dandy for country A to say they are pegging their currency to the US Dollar at 1 to 1, it is still the market that sets the true price of Country A's currency in relation to the US Dollar. Because of this, country A has to "defend" its currency peg, by buying its own currency and selling US Dollars when the value of their currency weakens below a 1 to 1 rate, and by selling their currency and buying US Dollars when it strengthens above the 1 to 1 rate. Here is a simple illustration of this:


As some of you who are a little more experienced in the markets probably know, some problems can arise with the above scenario, and there have been many examples in history of countries who were not able to hold their currency pegs. Probably the most famous example of this is referred to as Black Wednesday, when the famous speculator George Soros was credited with forcing the Bank of England to abandon their currency peg, causing the British pound to fall over 25% relative to the US Dollar in a matter of weeks.

So what does all this have to do with the US Dollar's Status as the world's reserve currency? Well, one of the main reasons that countries have in the past chosen to peg their currencies to the US Dollar, is because of the relative stability of the US Dollar in relation to other currencies. It is important to understand that not only do the currencies of countries who peg to the US dollar fluctuate in value along with the US Dollar, but their own monetary policy is basically tied to the monetary policy in the United States.

This is all fine and dandy so long as the monetary policy of the United States is considered sound, and so long as the currency does not fluctuate in a manner that adversely affects the economy of the country pegging to the dollar. Problems arise however when the dollar fluctuates in a way that adversely affects the economy of the country with the peg, and/or the monetary policy of the United States is set in a way that is not beneficial to those same countries.

There is a perfect example of this going on as of this lesson, with oil producing countries in the Middle East. As the price of oil has been high for so long, the economies of countries such as Saudi Arabia are booming, and money is flowing into those countries at a rate never seen before, creating all sorts of demand for the Riyal (Saudi Arabia's Currency). At the same time, the United States, the currency of which Saudi Arabia pegs their currency to, is going through an economic slowdown.

So what you have here is a situation where, if anything, monetary policy should be tightening in Saudi Arabia, and their currency should be strengthening. As their currency is pegged to the US Dollar however, they are affected by the loose monetary policy of the United States, throwing fuel on an already hot economy, and weakening their currency when it really should be strengthening. As we learned in our lessons on monetary policy in module 8 of our basics of trading course, this is a recipe for massive inflation, which it seems they are starting to see signs of now.

Scenarios such as this can cause countries to abandon their currency pegs or switch the currencies that they peg to something which is of major importance to the status of the US Dollar as the World's reserve currency.

There are many different scenarios such as the one above which can arise from countries who peg their currency to another. It is important for us to have a fundamental understanding of how to spot these scenarios, as whether or not countries continue to peg their currencies to the US Dollar, or move to a basket of currencies or another currency all together, will have huge affects on the value of the US Dollar going forward.

That's our lesson for today. In our next lesson we will wrap up our discussion on the US Dollar with a look at the final factors to consider when eying the status of the dollar, so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading!

hey david,

Felt like reviewing some of my knowledge of the fundamentals so i decided to look at this video first.

How is the Saudi's economy now in relevant to the US? have they started to tighten monetary policy or are they still pegging their currency against the greenback?!?

That is a very interesting example and i'll wonder what the Saudi's will do.
Btw can i ask, what is ur source for information such as this?
How do u find about such information or examples, do u just search the net, news ?!?

Thanks,
Peter

Hey Peter,

Glad to hear from you.

At my former job I traveled to several countries in the Middle East including Saudi Arabia to speak with banks about implimenting the forex platform that the company I worked for built. So I guess my first knowledge of the economy there came from my travels and needed to be able to discuss the economy there intelligently with clients on my trips there.

As far as where I find information the two best sources for getting an overview of the major fundamental factors affecting the world economy are in my opinion the Economist and the Wall Street Journal. I got a good basic understanding of the different factors at play from these two publications, and then used the internet to search out more specific information when things caught my interest.

I am not currently doing anything with Saudi Arabia at the moment, so to be honest I have not been closely following developments there. With this being said I am pretty sure that there has not been any adjustments yet to the dollar peg in the country and as of this post the economy is still doing very well primarily as a result of oil prices. The biggest problem I think they are facing at the moment is inflation which as I talk about in the above video is partially as a result of the dollar peg so we may see some changes to that in the future.

If you are interested in learning more about this I found the below document which may be of interest:

http://www.sama-ksa.org/en/news/unda...ary_policy.pdf

Hope that helps. As always if there are any other questions or comments on this one please feel free to post them below.

Best Regards,
Dave

__________________
Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

Great material David...

Enjoyed reading about this.. Had you thought about writing a book?
Sure I will buy it...

Now that you mentioned about the Saudis having problems with inflation, another currency with peg to the US Dollar is the Hong Kong Dollar. I go there pretty often... And it can be felt how bad it is.

Hong Kong it's considering to remove their peg from the US Dollar.. and possibly peg to the Chinese RMB (renminbi or Yuan) Not a sure thing as far as I know.

As we all know, Chinese Yuan is expected to appreciate against the US Dollar due to many factors such as Washington requesting China to remove it's peg, and now China desperate to fight inflation, among other factors.

Thanks for sharing all this great info Dave..
and congratulations for having your site growing and growing.

-Daniel

Hi David,

I am new to Forex. I will register on your site soon but for now I am engrossed in an educating myself phase. I would like to go through all courses from beginning to end. How much time would be needed? Do you have an estimation?
In addition to that maybe you could save me some time, I completed a Power Course with FXCM, so that tell you a little more about where I am at.

Thanks!

KP

Hi David,

Me again. Im the unregistered user on previous post. I looked closer and am zeroing in on the FX Course. How many hours of video are in that course? Just trying to pace myself to avoid information overload.

Hey Daniel,

Glad to hear from you and thanks for the comment you and everyone else who has been posting have been a big part of the site's success.

A few weeks ago I put all the text with charts etc from my basics of trading course into a book which we do sell on the site at the link below.

InformedTrades : Learn Trading. Trading Education. | - The InformedTrades Guide to the Basics of Trading Book

Once I am done with the forex course we will probably do something similar there I would imagine so you can look out for that in the future.

Sounds like you get to do a good bit of traveling with your job. I have not been to Hong Kong and don't know too much about the situation there but would love to go and learn more.

Best Regards,
Dave

__________________
Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

Hi KP,

Glad to hear from you.

Each lesson averages about 5 minutes and there are about 75 lessons in the basics of trading course and 50 in the forex trading course so that's about 10 hours total.

At the bottom of each video lesson there is the text transcript, so if you would like to save some time by skipping the things that you already know, I would recommend skimming over that part first and then watching the videos which you feel share something that you don't already know.

Best Regards,
Dave

__________________
Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.