Economics

In todays global economy, several countries have resorted to manipulating their currencies and employing exchange controls in order to protect their economies yet at the same time take advantage of global trade.  By using a fixed exchange rate or a pegged exchange rate, a country can stabilize the value of its currency against the value that it is pegged against.  In order to accomplish this, however, there is sometimes a need to employ exchange controls.  This is to be differentiated by the example of China that imposed limits of the trading and use of the their local currency in order to adjust its exchange rate and valuation vis--vis other foreign currencies.

These exchange controls can be done by applying the rule of supply and demand and influencing the strength of a currency by increasing interest rates or issuing bonds.   Essentially, a foreign currency will appreciate versus another currency depending on the worldwide or even local demand for that currency.  Applying the laws of supply and demand, when one good is highly sought after as compared to another, it is but logical that it demands a higher rate than the other commodity that is not so high in demand.  This is applicable to currency which operates in the same way.

Using this example, a country that does not employ exchange controls can still achieve a fixed exchange rate with another country by either buying or selling its own currency in an open market.  By using the foreign currency reserves of a country, a fixed exchange rate can still be maintained in relation to another country.  Maintaining foreign currency reserves of a country on whose currency the exchange rate is pegged (in cases of single currency pegs) or several currency (for basket of currency peg), will allow countries to maintain a relatively stable fixed exchange rate that can be monitored and controlled up to a certain extent in local regions.