Every country with its own money has to answer a blunt question: who decides what it is worth abroad? There are two broad answers. Let the market decide, which is called floating. Or have the central bank announce a price and defend it, which is called pegging. Most real systems sit somewhere between the two, but the extremes are the easiest place to see how each one works.
That choice shapes your conversions more than you might expect. It decides whether a rate sits nearly still for years or wanders every hour.
How a floating currency works
A floating currency has no official price. Buyers and sellers around the world set it by trading. The Bank of England says this about the pound in plain terms: it does not set the exchange rate, and the rate is decided by supply and demand. The US dollar, euro, pound and yen are the familiar examples, and you can watch one move on the EUR to USD page.
Floating has one big advantage. The exchange rate absorbs shocks. If a country’s exports collapse, demand for its currency falls, the currency weakens, and its goods become cheaper abroad. The adjustment is automatic and no one has to decide anything.
Volatility is the cost. A business, a student paying fees or a family expecting money from abroad faces a rate that can move before the money arrives. Floating gives up certainty for flexibility.
How a peg works
A peg fixes the price against another currency, most often the US dollar. The UAE dirham is a standard example: the national newspaper The National reports it has been officially pegged at 3.6725 dirhams to the dollar since November 1997. Hong Kong uses a version with a narrow band, which we will come to.
Here is the mechanism, step by step, because the mechanism is the whole point.
- The central bank announces the price, say 10 units of local currency per dollar.
- If the market wants more dollars than the peg allows, the local currency starts to slip below 10.
- The central bank sells dollars from its reserves and buys its own currency, which pushes the price back up.
- If the pressure runs the other way, it creates local currency and buys dollars, adding to reserves.
In effect the central bank is a buyer or seller of last resort at the announced price. As long as everyone believes it can keep doing that, the price holds without much effort. Pressure in one direction is easy to meet, since a central bank can always create more of its own currency. Pressure in the other direction is the hard case, because it needs a stock of dollars, and that stock is finite.
A worked example, with made-up numbers
All figures here are illustrative. A country pegs its currency at 10 per dollar and holds $20 billion in reserves. Suppose a bad harvest, a drop in export prices and a lot of nervous savers add up to net selling pressure of $400 million a day. Each day the central bank sells $400 million of reserves to hold 10.
How long can it keep going? $20 billion divided by $400 million is 50 days. After that, reserves are gone, and the peg breaks unless something else changes.
Now see what the peg bought and what it cost. A family sending $1,000 home gets 10,000 local units every month while the peg holds. Had the currency floated and slid to 11 per dollar, the same $1,000 would have bought 11,000, a 10% rise in the amount received, but a rise that also meant the currency had lost value for local buyers and made imports dearer. The peg shielded local prices from that shock for fifty days and charged $20 billion of reserves for it. That is the trade, in numbers.
Of course, reserves are not the only tool. A central bank can raise its interest rates sharply to make holding the local currency more attractive, which draws money back. But that hurts borrowers and slows the economy, and a government has to decide whether it is willing to pay that price.
Bands and floors: the in-between arrangements
Between fully fixed and fully free there is a wide middle. The Hong Kong Monetary Authority runs a linked exchange rate system that keeps the Hong Kong dollar between HK$7.75 and HK$7.85 per US dollar, which it calls the Convertibility Zone. At the strong end it sells Hong Kong dollars to banks for US dollars at 7.75. At the weak end it buys them at 7.85. Inside the band the currency moves a little with the market.
Even so, a band is small in practice. Convert US$10,000 at the strong edge and you get HK$77,500; at the weak edge, HK$78,500. The difference is HK$1,000, or 1.29%. You can see the current picture on USD to HKD, and compare it with a pegged Gulf currency on USD to AED.
The HKMA also explains an effect worth knowing. When it sells Hong Kong dollars to defend the strong edge, interest rates in Hong Kong dollars fall. When it buys them to defend the weak edge, rates rise. The peg works partly by pulling local interest rates into line, which is why a pegged country can’t set rates purely for its own economy.
Why pegs sometimes break
Every peg is a promise, and a promise is only as good as the reserves and the political will behind it. When either runs out, the peg goes. Switzerland offers a clean example, although it was a floor rather than a full peg. In September 2011 the Swiss National Bank said the franc must not trade below 1.20 per euro and that it would buy foreign currency in unlimited quantities to defend that line. On 15 January 2015 it announced it was discontinuing the minimum exchange rate, saying that enforcing it was no longer justified, partly because major central banks’ policies were diverging. It also announced a cut in the rate on sight deposits to minus 0.75%.
Notice what that tells you. Even a wealthy country with a well-regarded central bank decided to walk away from its own commitment. Pegs end by decision or by force, and the exit is rarely orderly.
What it means when you are sending or converting money
If your currency pair involves a peg, one side of the uncertainty goes away. A transfer between the UAE and a country whose currency floats against the dollar is exposed to the floating side only. Between two currencies pegged to the same anchor, the rate barely moves, so timing hardly matters and the fee and margin become nearly the whole cost.
But don’t confuse a stable rate with a cheap deal. A pegged rate tells you what the official middle price is. Providers still add their own margin on top, and that gap is separate from the peg. A fixed rate also isn’t a guarantee: if a peg is under strain, the official rate and the rate people can actually get may diverge in some countries. Arrangements differ, and the details change.
For a quick feel, scan the rates grid and note which currencies hold almost still against the dollar and which don’t. Rates refreshed hourly. A flat line is a policy choice, not a law of nature, and for anything large, ask your provider or a qualified adviser what could change.
Sources
- Who sets exchange rates? (Bank of England)
- How does the LERS work? (Hong Kong Monetary Authority)
- UAE dirham dollar peg (The National)
- The rationale for discontinuing the minimum exchange rate and lowering interest rates (Thomas Jordan, Swiss National Bank, via BIS)
- Swiss central bank puts a cap to the franc (MercoPress)
Checked: November 2026
