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.
When a country introduces a peg, the consequences do not always turn out to be positive. A country that is facing economic imbalance normally becomes the victim of high inflation and budget deficits. As a result, the affected country may use a reserve currency to peg its own legal tender. The domestic economy may get a boost out of this move, but it may soon collapse.
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.
Excessive credit creation. When a country introduces a peg, there is increased capital flow, and accumulation of the reserve capital. Because foreign interest rates tend to be lower than domestic ones, domestic banks and firms increasingly demanded loans in foreign currency. This situation will definitely trigger a financial distress in the long run.
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.
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 is also a major problem in many developing economies. When government officials are overly corrupt, the country fails to secure credit through stable channels. As a result, the limited options left include volatile credits that may damage the economy.
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.
When a country introduces a peg, the consequences do not always turn out to be positive. A country that is facing economic imbalance normally becomes the victim of high inflation and budget deficits. As a result, the affected country may use a reserve currency to peg its own legal tender. The domestic economy may get a boost out of this move, but it may soon collapse.
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.
Excessive credit creation. When a country introduces a peg, there is increased capital flow, and accumulation of the reserve capital. Because foreign interest rates tend to be lower than domestic ones, domestic banks and firms increasingly demanded loans in foreign currency. This situation will definitely trigger a financial distress in the long run.
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.
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 is also a major problem in many developing economies. When government officials are overly corrupt, the country fails to secure credit through stable channels. As a result, the limited options left include volatile credits that may damage the economy.
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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