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Pros for a Fixed/Pegged Rate Countries prefer a fixed exchange rate regime for the purposes of export

and trade. By controlling its domestic currency a country can – and will more often than not – keep its exchange rate low. This helps to support the competitiveness of its goods as they are sold abroad. For example, let's assume a stronger euro (EUR)/Vietnamese dong (VND) exchange rate. Given that the euro is much stronger than the Vietnamese currency, a T-shirt can cost a company five times more to produce an manufacture in a European Union country as compared to Vietnam. But the real advantage is seen in trade relationships between countries with low costs of production (like Thailand and Vietnam) and economies with stronger comparative currencies (the United States and European Union). When Chinese and Vietnamese manufacturers translate their earnings back to their respective countries, there is an even greater amount of profit that is made through the exchange rate. So, keeping the exchange rate low ensures a domestic product's competitiveness abroad and profitability at home. The Currency Protection Racket The fixed exchange rate dynamic not only adds to a company's earnings outlook, it also supports a rising standard of living and overall economic growth. But that's not all. Governments that have also sided with the idea of a fixed, or pegged, exchange rate are looking to protect their domestic economies. Foreign exchange swings have been known to adversely affect an economy and its growth outlook. And, by shielding the domestic currency from volatile swings, governments can reduce the likelihood of a currency crisis. After a short couple of years with a semi-floated currency, China decided during the global financial crisis of 2008 to revert back to a fixed exchange rate regime. The decision helped the Chinese economy to emerge two years later relatively unscathed. Meanwhile, other global industrialized economies turned lower before rebounding. (For more insight, check out Currency Exchange: Floating Vs. Fixed.) Cons of a Fixed/Pegged Rate Is there any downside to a fixed or pegged currency? Yes. This type of currency regime isn't all positive. There is a price that governments pay when implementing a fixed or pegged exchange rate in their countries. A common element with all fixed or pegged foreign exchange regimes is the need to maintain the fixed exchange rate. This requires large amounts of reserves as the country's government or central bank is constantly buying or selling the domestic currency. China is a perfect example. Before repealing the fixed rate scheme in 2010, Chinese foreign exchange reserves grew significantly each year in order to maintain the U.S. dollar peg rate. The pace of growth in reserves was so rapid it took China only a couple of years to overshadow Japan's foreign exchange reserves. As of January 2011, it was announced that Beijing owned $2.8 trillion in reserves – more than double that of Japan at the time. (To learn more, check out How do central banks acquire currency reserves and how much are they required to hold?) Read more:

thus leading to excess demand or excess supply The central bank needs to hold stocks of both foreign and domestic currencies at all times in order to adjust and maintain exchange rates and absorb the excess demand or supply Fixed exchange rate does not allow for automatic correction of imbalances in the nation's balance of payments since the currency cannot appreciate/depreciate as dictated by the market It fails to identify the degree of comparative advantage or disadvantage of the nation and may lead to inefficient allocation of resources throughout the world There exists the possibility of policy delays and mistakes in achieving external balance The cost of government intervention is imposed upon the foreign exchange market [6] . which allow firms to hedge exchange rate fluctuations The announced exchange rate may not coincide with the market equilibrium exchange rate. a country with poorly developed or illiquid money markets may fix their exchange rates to provide its residents with a synthetic money market with the liquidity of the markets of the country that provides the vehicle currency[14] A fixed exchange rate reduces volatility and fluctuations in relative prices It eliminates exchange rate risk by reducing the associated uncertainty It imposes discipline on the monetary authority International trade and investment flows between countries are facilitated Speculation in the currency markets is likely to be less destabilizing under a fixed exchange rate system than it is in a flexible one. since it does not amplify fluctuations resulting from business cycles Fixed exchange rates impose a price discipline on nations with higher inflation rates than the rest of the world.Advantages          A fixed exchange rate may minimize instabilities in real economic activity[14] Central banks can acquire credibility by fixing their country's currency to that of a more disciplined nation [14] On a microeconomic level. as such a nation is likely to face persistent deficits in its balance of payments and loss of reserves [6] Disadvantages        The need for a fixed exchange rate regime is challenged by the emergence of sophisticated derivatives and financial tools in recent years.