Definition: When a country pegs its currency to the U.S. dollar, this means it intends to control the value of its currency so that it rises and falls as the dollar does. There are at least 66 countries that either peg their currency to dollar or use the dollar as their own legal tender. That's because the dollar is the world's reserve currency, a status it's had since the 1944 Bretton Woods Agreement.

The next runner up, the euro, only has 25 countries that peg their currency to it, in addition to the 17 eurozone members. 

How Does a Dollar Peg Work?

To do this, it has to use a fixed exchange rate. Usually, a country will peg its currency to a certain dollar range, instead of a specific number. That's because the dollar's value changes too much on a daily basis to do otherwise. A country's finance minister will monitor his country's currency exchange rate relative to the dollar's value. If the currency falls below a certain range, he will buy dollars -- usually in the form of U.S. Treasuries. This increase the dollar's value so it once again falls within the intended range. If the dollar were to rise above the range, the country would sell its Treasuries to lower the dollar's value back within its targeted range.

China uses a fixed exchange rate, as opposed to the United States and many other countries that have a floating exchange rate. That's because it prefers to keep its currency low to make its exports more competitive.

In fact, every country tries to do this, but few have China's ability to keep it fixed. For more, see Currency Wars.

China's currency power comes from its exports to America, mostly consumer electronics, clothing and machinery. In addition, many U.S.-based companies send raw materials to Chinese factories for cheap assembly. The finished goods become imports when they are shipped back to the United States. For more, see U.S. Trade Deficit With China.

As a result, Chinese companies receive dollars as payments for these goods and services. They deposit the dollars into their banks in exchange for yuan to pay their workers. Banks send the dollars to China's central bank, which stockpiles them in its foreign currency reserves. This reduces the supply of dollars available for trade. That puts upward pressure on the dollar. For more, see Dollar Value.

China's central bank also uses the dollars to purchase U.S. Treasuries. It needs to invest its dollar stockpile into something safe that also gives a return, and there's nothing safer than Treasuries. China knows this will also further strengthens the dollar, lowering the yuan's value. For more, see U.S. Debt to China. 

Why Do Countries Peg Their Currency to the Dollar

As mentioned earlier, the U.S. dollar is the world's reserve currency, so this is one reason that countries peg to it. That means that most financial transactions and international trade is done in U.S. dollars. Countries that are heavily reliant on their financial sector, Hong Kong, Malaysia and Singapore, peg their currencies to the dollar. 

Other countries that export a lot to the United States, such as China, pegs its currency (the yuan) to the dollar to maintain competitive pricing. It tries to keep the value of their currency lower than the dollar. This gives it a comparative advantage by making its exports to America cheaper.  For more, see How Does China Influence the U.S. Dollar?

This is different from Japan, which doesn't exactly peg the yen to the dollar. However, it does try to keep the yen low compared to the dollar because it exports so much to the United States. Like China, it receives a lot of dollars in return. The Bank of Japan uses those to become the fourth largest purchaser of U.S. Treasuries for that reason.

Other countries, like the oil-exporting nations in the Gulf Cooperation Council, must peg their currency to the dollar because their primary export, oil, is sold in dollars. As a result, they became large owners of dollars in their sovereign wealth funds. These petrodollars are often invested in the United States to earn a greater return. For example, Abu Dhabiinvested petrodollars in Citigroup to prevent its bankruptcy in 2008. 

Countries that do a lot of trading with China or oil-exporting countries will also peg their currency to the dollar. Article updated March 5, 2015.