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I'm creating a country, and thinking of a future currency solution. Currently we use AUD, we eventually plan on creating our own currency the Ark. The Government plans on pegging the Ark directly to AUD, and citizens will be able to convert 1 AUD directly to 1 Ark, through our central government bank. 1 Ark back however will be $0.975AUD This will ensure a stable conversion and give an incentive to citizens to forfeit their AUD to Arks. The Government will maintain the approximate value (97.5% of Arks) to AUD in the case that every citizen wants to convert back to AUD.

However we plan to eventually de-peg from the AUD, so our government can print/digitize more currency, knowing that it will inflate the currency. By creating jobs & selling resources to create foreign reserves to buy-back Arks and reverse inflation. Regardless it's irrelevant what we do after we de-peg.

My questions are:

  1. Can our government create currency while pegged to another?
  2. How will the inflation of the AUD affect our currency & value?
  3. How should we safely and stably transition when we de-peg our currency?

Notes:

  • Not sure if this should be posted in money.stackexchange.com. But I posted it here for the world building aspect.
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    $\begingroup$ Please limit yourself to one question per post. $\endgroup$ – sphennings Oct 15 '17 at 2:43
  • $\begingroup$ @sphennings, I understand it goes against the rules, but the questions are rather closely related and opening 3 questions would be just spamming $\endgroup$ – mateos Oct 15 '17 at 3:10
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    $\begingroup$ I think the questions flowed naturally. As if it were a three-part single question. $\endgroup$ – elemtilas Oct 15 '17 at 3:16
  • $\begingroup$ It does state "Avoid asking multiple distinct questions at once", My questions aren't entirely distinct, they fall under the same topic of currency $\endgroup$ – mateos Oct 15 '17 at 3:24
  • $\begingroup$ The word "currency" does not mean "money". The part of money which exists as little pieces of paper ("currency") is relatively small; most money exists as numbers in databases. "Pegged" does not mean 1:1; it means "fixed rate of exchange". Converting AUD to Ark at par and Ark to AUD at 92.5% is stealing 7.5% of all the people's and businesses' money; there will be villagers in the streets with pitchforks. When pegged to a foreign currency you don't actually have a currency; you have a fancy name for the foreign currency, and you are directly hit by fluctuations in that foreign currency. $\endgroup$ – AlexP Oct 15 '17 at 6:04
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  1. Of course, this can be done! And it's been done. Take a look at the history of the Irish Pound since 1922. At first it was pegged to sterling, and remained so pegged until the 1970s when Ireland switched to the European currency. Since the introduction of the euro, the relative unpegged values have seesawed a bit.

A more extreme example is Ecuador which completely dumped its currency and simply uses US dollars.

  1. With your currency pegged to the AUD, its value will rise and fall with respect to other world currencies, though it will remain stable with respect to the AU$, so long as you maintain tight control of your printing presses!

  2. A much more dangerous proposition, this. As you can see with the Irish example, as soon as they switched to the euro, the principal unit of money has a lower value than previously. As of right now, the euro is 89p. If the Irish had stayed on sterling, their pound would be 100p.

The best thing you can do here is ensure that you have a strong & diverse economy. A single sector economy, be it raw material exports or tourism will be bound to backfire as soon as some overseas market shifts or some disaster strikes and cripples your resorts.

The next thing you have to do is keep a tight rein on those printing presses. Small, newly independent countries have a great tendency to see the printing press as a way out of economic woes. Take a look at the history of the Zimbabwe dollar. After independence, the Rhodesian dollar was set at 50p sterling in 1970, and remained at that value until 1980. After that time, when Rhodesia became Zimbabwe, its value quickly and alarmingly eroded. (This would be under the tender loving care of Mugabe.) Starting at 50p, by 2006, the ZD was at a million to one against the pound sterling. Within a couple years of this time, hyperinflation was so bad, the government gave up trying to calculate how bad it was. Bank notes in the hundred trillion denomination soon became worthless. Talk about money not being worth the paper it's printed on! In 2015, when the government declared the ZD to be worth literally -0-, they credited everyone with USD5 if they had ZD175,000,000,000,000,000 on deposit.

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The Hong Kong dollar is pegged to the US dollar. See @elemtilas's answer for other examples.

if your currency is pegged to the AU dollar it will experience the same inflation and valuation as the AU dollar. Ditto the HK and US dollars.

The same way any currency does when it changes its basis for rates of exchange. Cross your fingers and hope your economy to strong enough not to make waves. Vide the Australian dollar back in the 1980s when they "floated" the dollar, taking it off a Treasury mandated rate of exchange.

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You can absolutely peg your currency to AUD, or dollars, or gold, or whatever you want. All that means is that the government commits to exchanging the currencies at that predefined rate.

What that means is that it's easier to trade with AUD-land, and that (hopefully) the big shocks and exchange-rate swerves that a minor currency is heir to will be less.

However ... you can still get yourself in trouble. Why? Because whatever you say your currency is worth, it has a real worth, defined by the people who want to buy or sell it. You've pegged your currency, which means that if you then print a huge number of Arks (which inside the country devalues the currency) you still have to exchange them for .95 AUD. You can go broke fast that way. Also, nobody will want to buy them. So you have to coordinate your fiscal policy with outsiders more closely than you might like...

Edit: Here's a very nice article worth reading: https://en.wikipedia.org/wiki/Fixed_exchange-rate_system#Advantages Special attention to the Advantages & Disadvantages sections.

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  • $\begingroup$ We will have a law restricting that Ark's are the only currencies that will be traded within the currency. We won't inflate the currency either. Meaning we'll only create what is transferred. (atleast until we depeg) for example: if citizens give a total of 1m AUD, there will be 1m Arks, an since we will Guarantee a 97.5% exchange, Those 1m Arks will be worth 97.5% AUD. $\endgroup$ – mateos Oct 15 '17 at 8:58
  • $\begingroup$ "All that means is that the government commits to exchanging the currencies at that predefined rate." Very true and it works fine until Governments start getting overstretched and can't afford to maintain the peg as happened in Switzerland recently $\endgroup$ – Slarty Oct 15 '17 at 9:58
  • $\begingroup$ @Albert the other side of the coin is that you do need people to exchange their AUD for Arks at 2.5 percent-points below the nominal rate. $\endgroup$ – HAEM Oct 15 '17 at 10:08
  • $\begingroup$ @Albert: "We will have a law restricting that Ark's are the only currencies that will be traded within the currency [area]": So you are a fully self-sufficient country, with no need of international trade. In this case it makes no sense whatsoever to "peg" your currency to Martian Mollars or whatever, because you don't trade with Mars. But if you do want to trade with foreigners then by necessity your currency must be exchangeable with the foreign currency; and in this case it doesn't matter what you say its value is, because its value is exactly how much the traders want to pay for it. $\endgroup$ – AlexP Oct 15 '17 at 11:17
  • $\begingroup$ @AlexP I meant, the only currency used with consumer-business will be the Ark. Companies (besides ones to do with foreign trade) will use Ark's as their primary currency if you get what I mean $\endgroup$ – mateos Oct 15 '17 at 12:30

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