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.
The effect of globalization may also prove disastrous at times. Such an event leads to increased capital mobility due to globalized financial markets. When impediments such as capital controls are eliminated and derivatives that increase competition are created, emerging economies can be faced by difficult challenges because they lack institutions that are adequately equipped to control such a liberalized market.
When government creates lot of credit, which is normally the result of a peg, there tends to be an improved capital flow and a larger reserve capital. However, this lowers foreign interest loans to the domestic legal tender. As a result, borrowers and banks start taking credit in foreign currencies so as to incur lower costs. In the end, this will result into a financial distress.
Too much liquidity could also create a moral hazard. Banks may be influenced to give easy credit so as to gain big if they happen to make profits. This is because hidden government guarantees shield them from losses. The taxpayers would help shoulder the losses if the situation turns out to be unprofitable.
Real estate bubbles and bank runs. In most cases, the expansion of domestic credit generates a boom in the property industry and equity markets. However, the boom is soon followed by fall in prices as the market becomes saturated. This leads to an accumulation of unpaid loans. Most of the policies introduced to curb the situation normally lead to high interest rates.
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.
A country can fall into crisis currency either through internal or external forces. However, most of these signs can be seen before things get out of hand. In most cases, it is possible to avoid financial distress by passing policies that look at long-term stability and financial growth of the economy.
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.
The effect of globalization may also prove disastrous at times. Such an event leads to increased capital mobility due to globalized financial markets. When impediments such as capital controls are eliminated and derivatives that increase competition are created, emerging economies can be faced by difficult challenges because they lack institutions that are adequately equipped to control such a liberalized market.
When government creates lot of credit, which is normally the result of a peg, there tends to be an improved capital flow and a larger reserve capital. However, this lowers foreign interest loans to the domestic legal tender. As a result, borrowers and banks start taking credit in foreign currencies so as to incur lower costs. In the end, this will result into a financial distress.
Too much liquidity could also create a moral hazard. Banks may be influenced to give easy credit so as to gain big if they happen to make profits. This is because hidden government guarantees shield them from losses. The taxpayers would help shoulder the losses if the situation turns out to be unprofitable.
Real estate bubbles and bank runs. In most cases, the expansion of domestic credit generates a boom in the property industry and equity markets. However, the boom is soon followed by fall in prices as the market becomes saturated. This leads to an accumulation of unpaid loans. Most of the policies introduced to curb the situation normally lead to high interest rates.
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.
A country can fall into crisis currency either through internal or external forces. However, most of these signs can be seen before things get out of hand. In most cases, it is possible to avoid financial distress by passing policies that look at long-term stability and financial growth of the economy.
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