Causes of currency crisis

The world has been through quite a few currency crises in the past few years. Those
faced by the United States, Spain, and Greece particularly stood out, considering just
how many news stories focused on the instability of these countries at the time of
their crises.

We’ve heard the word ‘crisis’ thrown around millions of times since the first rise in
sightings of extreme currency crises in 2009. Since then, it seems to have lost some
strength in meaning. When you use a word often enough, it is bound to become
commonplace.

However, despite the fact that currency crises have become commonplace according
to how often they have been occurring, they are still very serious matters. It is not
something to take lightly, and it hopefully never will be. Though we know what a
currency crisis involves and how it affects a country as well the lives of its people,
it is not often that we hear what exactly occurred to cause such a crisis. The following
are the top 4 causes for a currency crisis.

1. Decline in currency value

The decline of value of a country’s currency is actually the first step in what seems
to be a steady decline toward a currency crisis. It acts very much like an off-balance
domino that makes one false move and leads to the unfortunate demise of all
dominos in close relation to it. Once the value of a given currency decreases,
exchange rates lose their stability because this lower valued currency is now unable
to buy the same amount of currency as it once could.

Now, having an unstable exchange rate has a negative effect on forex traders in that
they become afraid of this currency’s value remaining low. So, expectedly, they take
action by doing something called ‘capital flight’, taking back their money from that
country’s economy. The thing is, when traders begin to remove their money and
exchange these domestic investments for foreign currencies, it unfortunately causes
the exchange rate to drop even lower. Economies that have experienced this and are
therefore not particularly stable include the countries of Brazil, Indonesia, and
Turkey. These are called emerging markets.

2. Borrowing money

As a result of having an increasingly low exchange rate and traders removing their
money and exchanging it for other types of currency, a country may have no choice
but to borrow money in order to raise their exchange rate and hope to bring traders
back.

This is not as easy or as predictable as it looks, however. Sometimes borrowing

money leads to no substantial change in exchange rate and no traders returning with
their funds. When this happens, the country is left not only with a low exchange rate
and no trader interest, but on top of this they are now indebted to the country whose
money they borrowed from as well.

3. Current Account Deficit

A current account deficit is caused by a country’s inability to export an equal amount

of goods, or at least equally valuable goods, as those that are imported from
elsewhere. When a country is unable to provide goods that are as valuable to their
neighbors as the goods received from these neighbors, a current account deficit is
what results.

This means that the country is spending more than it is receiving in terms of the
trading of goods. In order to pay for this deficit, the country needs to have a surplus
elsewhere, on the Capital account for example.

Countries most at risk from a currency crisis

What do the Turkish lira, the Iranian rial, the Russian ruble, the Indian rupee, the
Argentine peso, the Chilean peso, the Chinese yuan and the South African rand all
have in common? They’ve all declined steadily this year, and some have depreciated
dramatically in the past two weeks alone. The Turkish lira, for example, dropped
steeply late last week. At nearly $200 billion, almost 50 percent of Turkey’s gross
external debt is denominated in dollars. (Turkey’s General Directorate of Public
Finance, which, unlike BIS, accounts for financial borrowers, puts that figure at
nearly 60 percent.) But this isn’t the whole story. The whole story is that each of
these countries is sitting on a ticking time bomb of U.S. dollar-denominated debt.

This story has been long in the making. In the 1990s, many countries began to
accumulate large amounts of debt denominated in U.S. dollars. It was an effective
way to kick-start economic activity, and so long as their own currencies remained
relatively strong against the dollar, it was fairly risk free. From 1990 to 2000, dollar-
denominated debt tripled from $642 billion to $2.17 trillion.

The problem may now be coming to a head. Dollar-denominated debt has ballooned.
In its latest quarterly report, the Bank of International Settlements found that U.S.
denominated debt to non-bank borrowers reached $11.5 trillion in March 2018 – the
highest recorded total in the 55 years the bank has been tracking it. Meanwhile, the
dollar has strengthened amid a tepid global recovery from the 2008 financial crisis.
As the currencies of indebted countries weaken against the dollar, it is becoming
harder for some countries to pay their debts. This could be a bubble waiting to pop,
especially if vulnerable countries don’t have the monetary policy options to protect
themselves.