Since the early 1990s, many investors have been caught unprepared by economic instability. This has always led to capital flight and runs on currencies from international financiers. Whether these actions are guided by gut instinct or quantifiable measures is unclear. However, such circumstances are avoidable if people can understand the cause of crisis currency. Below is a discussion of some common causes and how to avoid the situation.
The introduction of a peg. This is common in many developing countries, especially those suffering from economic imbalances such as budget deficits and high inflation. This may force the affected country to peg its legal tender to a reserve currency. This will lead to a stable domestic economy. This creates a long-term problem because it will attract investors who will over rely the foreign exchange.
Another major problem is globalization. When financial markets become globalized, it increased capital flow. The riddance of capital flows, liberalization of domestic markets, financial deregulation, and introduction of liberal derivatives leads to increased competition in the financial sector. Moreover, this situation lowers transaction costs, which creates a boom. However, without well-established control measures, this can lead to a crisis.
Excessive credit creation can also become a big problem. When there is a peg on the domestic currency, the reserve capital rises and cash flow increases into the local market. Consequently, the lower foreign interest rates will compel banks and other firms to seek credit in foreign denominations. In the long run, the country could face financial distress.
Moral hazard. When there is too much liquidity, banks tend to give credits more easily. Hidden government guarantees create a situation of vulnerability because the banks give large loans so that they can earn large profits is things turn out positive. However, if there are losses, society helps them shoulder the burden.
Bubbles in the real estate sector can also cause economic instability. For a while, there is an expansion in the in the value of the domestic credit as well as equity markets. However, as the property industry stabilizes, prices begin to fall. When this happens, it results into bank runs, and banks consequently suffer from accumulated unpaid loans. High interest rates soon follow, which creates currency crisis.
Contagion of currency crises. Many other factors may contribute to a financial distress. These include pessimism from investors about the credit worthiness of a country, high volatility of short-run capital, a current recession, a new institutional framework, political unrest, and even liberalization of local markets without flanking regulative measures. All these factors are considered by investors and they may create doubt on economic potential.
Corruption and nepotism also affect the financial situation in a country by great depths. These factors act to repel more stable forms of foreign investment. Therefore, countries are left to dependent on volatile foreign credits to finance growth.
Countries can easily avoid crisis currency by implementing policies that target long-term growth. Selling foreign reserves and having the payment in domestic money could help increase capital outflows. As a result, an internally denominated asset would be created.
The introduction of a peg. This is common in many developing countries, especially those suffering from economic imbalances such as budget deficits and high inflation. This may force the affected country to peg its legal tender to a reserve currency. This will lead to a stable domestic economy. This creates a long-term problem because it will attract investors who will over rely the foreign exchange.
Another major problem is globalization. When financial markets become globalized, it increased capital flow. The riddance of capital flows, liberalization of domestic markets, financial deregulation, and introduction of liberal derivatives leads to increased competition in the financial sector. Moreover, this situation lowers transaction costs, which creates a boom. However, without well-established control measures, this can lead to a crisis.
Excessive credit creation can also become a big problem. When there is a peg on the domestic currency, the reserve capital rises and cash flow increases into the local market. Consequently, the lower foreign interest rates will compel banks and other firms to seek credit in foreign denominations. In the long run, the country could face financial distress.
Moral hazard. When there is too much liquidity, banks tend to give credits more easily. Hidden government guarantees create a situation of vulnerability because the banks give large loans so that they can earn large profits is things turn out positive. However, if there are losses, society helps them shoulder the burden.
Bubbles in the real estate sector can also cause economic instability. For a while, there is an expansion in the in the value of the domestic credit as well as equity markets. However, as the property industry stabilizes, prices begin to fall. When this happens, it results into bank runs, and banks consequently suffer from accumulated unpaid loans. High interest rates soon follow, which creates currency crisis.
Contagion of currency crises. Many other factors may contribute to a financial distress. These include pessimism from investors about the credit worthiness of a country, high volatility of short-run capital, a current recession, a new institutional framework, political unrest, and even liberalization of local markets without flanking regulative measures. All these factors are considered by investors and they may create doubt on economic potential.
Corruption and nepotism also affect the financial situation in a country by great depths. These factors act to repel more stable forms of foreign investment. Therefore, countries are left to dependent on volatile foreign credits to finance growth.
Countries can easily avoid crisis currency by implementing policies that target long-term growth. Selling foreign reserves and having the payment in domestic money could help increase capital outflows. As a result, an internally denominated asset would be created.
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