Special Problem
Topic:
Currency Crisis
Submitted to:
[Link] Zia
[Link] semester 4th
Institution of Business Management Sciences
University of Agriculture Faisalabad
Table of Content
Introduction
i. What is currency?
ii. What is crisis?
Which problem we face due to currency crisis
How to control
Theories
Conclusion
Why I choose this topic
Abstract:
Currency and banking crisis in Latin, America, Europe, and Asia over the past three decades
have generated substantial literature on their causes. The literature on currency crisis begins
with models developed to explain crisis experienced by some Latin American countries in
the late 1970s. These models views currency crisis are begin caused by weak economic
fundamentals. Following the collapse of the European Monetary System in 1992, the so-
called second-generation models of currency crisis emerged. These models show that
currency crisis can occur due to certain government policy actions, self-fulfilling expectations
of market participants, and possibilities of multiple equilibriums, even in the absence of
fundamental weaknesses. The theoretical currency crisis literature has expanded further
since the 1997 Asian financial crisis. The so-called third-generation models view a currency
crisis as a run on an economy or a financial panic.
Introduction:
In 1990s there are many kinds of currency crises. Sometime currency crises predictable
but sometime very complex. It may predictable by governments, investors, central bank or
any combination of actors. But the result is always the same. The negative reason is wide-
scale of economic damage and loss of capital. Crises have developed when investors’
expectations cause significant shift in value of currencies. Sometime currency crises like a
just symptom not the disease of great loss of economy.
Fight with currency crises:
Central bank are first line in maintain the stability of a currency. In order to increase
the interest rate, central bank can lower the supply which in turn increase demand for
currency. The bank can do this by selling off foreign reserve to create capital outflow. When
the sells the portion of its foreign reserves it receive payment in domestic currency, which it
holds out of circulation as an asset.
Example of currency crises:
Asian crises of 1997:
Southeast Asia was home to the tiger economies including Singapore, Malaysia, and
China & South Korea and Southeast Asian crises. Foreign investment poured/paid/consumed
in four years. Underdeveloped economies were experiencing rapid rates of growth and high
level of exports. The rapid growth was attributed to capital investment project, but the
overall productivity did not meet expectations. While the exact cause of the crises is
disputed, Thailand was the first to run into trouble.
Lesson learned from currency crises:
Trade surplus and low inflation.
What is Currency?
A currency, i8n the most specific sense is money in any form when in use or circulation as a
medium of exchange, especially circulating banknotes and coins. A more general definition is
that a currency is a system of money in common use, especially for people in a nation.
Currency is a medium of exchange also for goods and services. In short, its money, in the
form of paper, usually issued by a government accepted at its face value as a method of
payment.
What is Crisis?
A time when a difficult or important decision must be made.
A crisis is any event that is going to lead to an unstable and dangerous situation affecting an
individual, group, community, or whole society.
Problem of Currency Crisis:
A currency crisis, also known as the Balance of Payment crises, is a situation in which a
nation is suffering from a chronic balance of payment deficit. This problem exists when a
nation is unable to finance the imports and debt repayments.
Many of currency crisis were due to inconsistent government macroeconomic policies.
Explanations of currency crisis are based on government mismanagement.
Contrasts with banking literature where central banks/government are the solution
not the problem.
How do control Currency Crisis?
The best solution to a currency crisis is avoiding them in the first place with preventative
measures. Floating exchange rates tend to avoid currency crisis by ensuring that the market
is always setting the price, as opposed fixed exchange rates where central banks must fight
the market.
Causes of Currency Crisis:
Speculation
Deficit financed by inflation
Weak financial system
Recent deregulation of financial markets
Weak economic performance
Political factors
External factors such as interest rate
Choice of exchange rate system
What to do in economic Crisis?
Remember the stock market is as much about human emotions as it is about financial
data!
Now is a good time to stock up.
Stay focused on the things that really matter in life!
Top up your emergency fund
If you worried about a volatile economy, one of the best things you can do is make sure you
have 3 to 6 months of living expenses in a saving account.
Find easy ways to cut your overhead costs
We live in a day and age where having o good phone plan, solid WiFi, and plenty of content
to watch on TV is a foregone conclusion. But that does not mean you should overpay for it.
Supplement your income
If you truly are worried about tough economic times ahead, then you need to do everything
you can do insulate yourself. One of the best ways you can do that is by increasing your
earnings in anticipation.
Pay down high interest debt
Paying down your high interest debt is critical because it takes pressure off of your cash
flows if you run into financial trouble. Not having a massive credit card bill every month will
help you stay above water until things settle down.
Keep investing
When the stock market is falling and everyone is panicking, it will seem counterintuitive to
keep investing. You have to remind yourself that it’s practically impossible to effectively
time the market.
Boost your credit score
Finally, it can seem silly to worry about your credit score when you are worried about the
economy tanking. But what happens if you are ready to buy your first home in the midst of
the recession? It might actually be the perfect time to buy if prices begin to drop, but getting
a loan during a recession is more complicated.
Theories:
In the basis of the theory of currency crises is the famous international finance trilemma,
according to which a country can choose only two or three policy goals: free international
capital flows, monetary autonomy, and the stability of the exchange rate.
First generation:
In the early 1980s, the first generation models of currency crisis were constructed. The idea
is a very simple one. The model assumes that there is something wrong with economic
fundamentals: a policy inconsistent with a fixed exchange rate is adopted.
Second generation:
The second generation model of currency crisis. In the second generation model of crisis, the
economy has a fixed exchange rate regime. The high interest rates motivate traders to keep
their money in the domestic currency as it gives them a higher return.
These models show that doubts about whether a government is willing to maintain its
exchange rate peg could lead to multiple equilibrium and currency crises
In these models, self-fulfilling prophecies are possible, in which the reason investors
attack the currency is simply that they expect other investors to attack the currency
Third generation:
The third generation model of currency crisis. In the third generation model of currency
crisis, the problem is liquidity. The economy is working well without large deficit and high
inflation. Therefore, the warning sign for this type of a currency crisis is having more short-
term debt than foreign exchange reserves.
These models explores how rapid deteriorations of balance sheets associated with
fluctuations in asset prices, including exchange rates, can lead to currency crisis.
These models are largely motivated by the Asian crisis of the late 1990s. IN the case
of Asian countries, macroeconomic imbalances were small before the crisis – fiscal
positions were often in surplus and current account deficits appeared to be
manageable, but vulnerabilities associated with financial and corporate sectors were
large.
Conclusion:
The global financial rises started with a collapse in the real estate industry that later spread
the adverse economic instability to other sectors of the economy. Slow economic recovery
in the United States is attributed to inefficient economic policies implemented to realize a
boom.
Why I choose this topic:
The speed of the financial liberalization was too fast, financial companies
did not have enough time to adapt the fierce competition for market shares
by freely by offering loans to households and firms.
Analyzed 76 currency crises and 26 banking crisis for 20 countries during
1970 to mid-1995.
One of the main findings is that financial liberalization often precedes
banking crisis.
Lack of net worth for my institutions as they entered the 1980s, and a
wholly inadequate net worth regulation.
Another factor was the efforts of the Federal reserve to wring inflation out
of the economy with a series of rises in short-term interest rates. This led to
a scenario in which increases in the short-term cost of funding were higher
than the return on portfolios of mortgage loans.