Currency Crisis

Currency Crisis

Emerging markets were seen to be the right candidates for saving the global economy from ultimate collapse. For instance, it is evident that most of the emerging markets have exhibited uncanny characteristics. Chinese economy is growing against all odds. The private enterprise mechanism of the West is held in disdain by the communist regime. The rule of the law is alien to the Chinese government. Add the fact that their currency is forever undervalued against the dollar in order to gain export price competitiveness (Birdsall and Fukuyama 2011). In 2009, the gross domestic product in the developing world went down by about 3.43%. On the other hand, the GDP in emerging markets rose by about 3.1 % (Aschinger, 2001, Birdsall and Fukuyama 2011). Investors continued to put their money in the emerging markets as they were looking for opportunities where they could grow their money.

Multinational Corporations (MNCs) took the opportunity and poured their money into these economies, investing in facilities as well as buying equipments. However, investments in the emerging markets are dissimilar to what transpires in the developed economies. Capital is poured into the country’s economy when it is doing well. However, when the economic cools down, investors dump the local currency. This leaves a huge pile of a devalued local currency that central banks find it hard to prop up. However, in the developed world, the reverse is the case as investors will continue to hold on to the currency when the economy is not performing well. This paper will discuss why countries have not learned from previous mistakes.

Literature Review

Financial turmoil continues to occur in many parts of the world. Policy makers, researchers, governments, and even credible institutions such as the World Bank have tried to analyze the causes as well as mitigation efforts to minimize future occurrences. However, some scholars point that another financial crisis is inevitable because people do not seem to learn from their mistakes (Aschinger 2001, Birdsall and Fukuyama 2011, Krugman n.d). By reviewing the available literature, it becomes apparent that currency crisis has gone through generations. The first generation identifies significant misalignment between macroeconomic policies and the level at which the currency is pegged (Krugman n.d.). Krugman (n.d.) argued that the over-expansionary fiscal deficit, which is financed by money creation, leads to a deficit in balance of payments. According to Krugman, to defend the exchange rate peg, the government must run down its foreign exchange reserve. A steady decline in the foreign reserve forces a country to devalue its currency in order to the exchange rate in line with the macro-economic policy situation of the country. Therefore, based on this argument, the currency crisis emanates from inappropriate policies of the government.

On the other hand, the second-generation theories try to accentuate the actuality of multiple equilibria and self-fulfilling prophesies (Aschinger 2001, Birdsall and Fukuyama 2011). The generation models provide an avalanche of consequences that befall countries because of over-investment induced by moral decadence. The financial profligacy is borne out of implicit guarantees of private debts by the government. In the international market, the guarantee is rooted in policies embraced by the International Monetary Fund (IMF).

The second-generation models are based on the ratio of short-run external debt to foreign exchange reserves to be the genesis of investor panic. In their work, The Onset of the East Asian Financial Crisis, Radelet and Sachs (1998) try to investigate the causes of the 1997 Asian Financial Crisis by placing emphasis on empirical data. The researchers point out that financial panic was the major driver of the crisis. According to the researchers, the crisis was propelled by large inflows of funds from foreign investors into Asian financial system (Aschinger 2001, Birdsall and Fukuyama 2011). Because of the huge sums of money that were entering into the Asian financial markets, the study points that the financial system started to panic. The paper finds significant weaknesses in the macro and micro-economic fundamentals in most Asian countries. Such weaknesses as the authors indicate were not sufficient to absorb any shocks emanating from panic among the financial institutions, and panic among the international investors (Kanaoka 2013). In addition, there were no sufficient fall back mechanism in place, especially from the international institutions to arrest the situation once the crisis started (Aschinger 2001, Birdsall and Fukuyama 2011).

The idea behind this model is that if creditors decide to leave a certain country, they would not roll the short-term credit. When the ratio of short-run debt to foreign exchange reserves (SD/FX) is more than one, the foreign investors are in a position to collect short-term loans. This is because the government can bail out the private sectors as long as it is willing. Therefore, when the ratio of SD to FX is greater than 1, investors are not likely to panic. However, if the ratio is less than one, foreign investors panic because they recognize that the government would be unwilling to bail out private sector or its short-term obligation when they are due. One of the possible likelihood of SD to FX ratio going below 1 would be investors withdrawing their support from a country, thus creating a crisis (Aschinger 2001, Birdsall and Fukuyama 2011).

Therefore, the researchers identify three critical aspects that made the Asian situation dire. First, it was the panic among the international investors and Asian financial institutions. Secondly, there were weak institutional and regulatory frameworks within the Asian tigers. Finally, there were no sufficient mechanisms in place to help rescue the crisis. The combination of these factors led to huge withdrawal of foreign capital from the Asian countries, leading to the crisis. Callahan and Turbeville (2014) argued that the rise of lightly regulated financial institution with complex balance sheets remains unregulated. Indeed, the amount of money flowing through such unregulated financial institutions is enormous and spells doom in the near future.

This argument is further collaborated by Aschinger (2001), who argues that the Asian crisis started building up because of the high capital inflows, which brought about a high accumulation of credits and boom in the equity and real estate sectors. Aschinger writes, “moral hazard driven by implicit guarantees, poor risk management and a lack of supervision of the banking system produced a high number of falling credits which led to real estate and bank crisis”( 2001, p. 157). Therefore, the lack of proper regulatory framework, corruption, and nepotism were the instrumental in the Asian crisis.

Sergie (2014) observes that a shaky economic environment takes years to develop. However, the author argues that financial crises take shape rapidly. The author sees Thailand’s action to float its currency, the baht, after abandoning the dollar as the main trigger of the Asian financial crisis of 1997. Thailand’s plummeting currency caused investors to reevaluate the other economies in the region. The investors, after reassessing the condition in Asia, decided to pull out their investments in countries such as Indonesia, Malaysia, Taiwan, and South Korea.

The third generation models look at the moral make-up of governance and individuality as the main problem in commercial dealings (Corsetti, Pesenti and Roubini n.d.). Corsetti, Pesenti and Roubini (n.d.), argued that cronyism, complacency, and careless in financial dealings are the hallmark of the third generation theories. Implicit guarantees can give impetus to complacency. People can take a reluctant attitude if they know they will be bailed out in case of a crisis (Corsetti, Pesenti and Roubini n.d.). The researchers note that creditors should not rely on bail outs by the governments or from any international rescue programs. Risks should be borne by creditors themselves instead of looking for help from the outside. Corsetti, Pesenti and Roubini concluded that currency crises are occasioned by moral rot and economic sins committed by policy makers. However, as noted by Callahan and Turbeville (2014), another crisis is bound to occur because, despite the magnitude of fraud committed, there is no financial executive who has faced criminal charges. If prosecution were instituted against all the people involved, this could be a deterrent to future financial misappropriation.



The country’s currency, the peso, fell by 23% in January 2014. This was the most dramatic depreciation since the country’s 2002 financial woes. The crisis was triggered by the country’s non-intervention approach to maintain the value of the currency (Aschinger, 2001, Callahan and Turbeville 2014, Birdsall and Fukuyama, 2011). According to Xie and Detrixhe (2014), “ Argentine policy makers devalued the peso by reducing support in the foreign exchange market, allowing the currency to drop the most in 12 years to an unprecedented low” (par. 2).


The Turkish currency plummeted by between 6 and 9% in January 2014 (Xie and Detrixhe 2014). The country’s central bank announced plans to tame the depreciation of the currency by raising its benchmark lending rate to 10% from 4.5 % (Xie and Detrixhe, 2014). The currency experienced some turbulence, but has experienced a slight recovery.


Following Fed’s announcement, Venezuela devalued its currency for airline tickets and FDI (Xie and Detrixhe 2014). According to Xie and Detrixhe (2014), in January, the international reserves were at their lowest in 10 years.

South Africa

The South African rand went down by about 8 % in January 2014 (Xie and Detrixhe 2014). This was the lowest level since 2008. Further, the currency continued to sink low even in the wake of the monetary approach mooted by the country’s central bank. The central bank raised its benchmark rate to 5.5 % from 5.0 % (Xie and Detrixhe 2014).


Russia has not taken any measures to tame the currency crisis. In January, the country’s currency fell by about 7% (Xie and Detrixhe 2014). This was the lowest level in five years. However, unlike the efforts put forward by central banks in other emerging markets, Russia has not taken any measures to tame the depreciation.


In May 2013, FED Chairman announced the plan to stop buying bonds by mid 2014. This announcement caused problems in the international markets as the number of currencies in the emerging markets depreciated in their value between 3 and 15% to the US dollar (Xie and Detrixhe 2014). However, when the Chairman announced on September of the same year that Fed would not be rolling back on buying bonds, the currencies in the emerging markets rose between 1 and 3 % to the dollar (Xie and Detrixhe 2014, Krugman, n.d).

The panic in the emerging economies is a pointer to a number of factors (Aschinger 2001, Birdsall and Fukuyama 2011). First, it shows that emerging markets do not have better protection mechanisms to safeguard their currencies. The lessons from the past do not seem to resonate with the leaders in all countries affected by currency crisis. As identified in the literature review, putting a lot of money into the economy can be disastrous in case investors panic. Fed has pumped a lot of money in the international market amounting to $ 85 billion every month. With the announcement to stop buying bonds, Fed was sending a signal that there would no longer be easy money. This shows that development in the emerging markets will be slow and at the same time expensive (Callahan and Turbeville 2014).

Another important aspect noted in the literature review was the extent of corruption and nepotism in the corporate world. These vices should be put to an end because they contributed significantly to currency crisis (Aschinger 2001, Birdsall and Fukuyama 2011). Credit should not be provided based on personal relationships. Any loan should be provided to the borrower based on their creditworthiness and their ability to repay the loan. If efficiency were not the basis of lending, then a financial problem would be inevitable.

Poor regulatory framework is the basis of the 2008 financial crisis that affected mots European countries. Indeed, the reasons for the crisis bedeviling Europe as well as other countries are well known. There should be a clear regulatory framework for each country’s financial institutions as well as the real estate sector. Financial institutions should not lend money to people who are most likely to default on loan repayments (Royo 2010, Krugman n.d). In Spain, the cajas did not provide the relevant information to the government, making it hard to determine their real estate exposure. Indeed, instability in the banking sector leads to low confidence by investors. A market with low investor confidence will struggle to achieve economic growth or recovery from financial difficulties. In summary, the main challenge facing the Euro-zone is the harmonization of the countries fiscal policies. In addition, the Euro-zone should have a clear regulatory framework for each country’s financial institutions and the real estate sector (Aschinger 2001, Birdsall and Fukuyama 2011). At a time when the emerging markets were receiving more money, they should have reinforced proper mechanisms or adjusted their policies. Instead of enjoying easy money from the international investors, the emerging economies were not adjusting their policies to deal with imbalances. This was the reason for the reaction after Fed’s announcement.


This paper has looked at the currency crisis in Asia as well as in emerging markets. The cause of the crisis can be attributed to three major problems. These include misalignment between macroeconomic policies, existence of multiple equilibria and self-fulfilling prophecies, and implicit guarantee of a country’s private debt by the government or the guarantee of foreign debts by the IMF.

From this discussion, it is evident that the world economies do not seem to learn from past mistakes. One of the lessons to be deducted from this study is that different shocks can cause some of the same symptoms. The correct intervention mechanism could as well depend on the type of shock and not the subset of the symptom. Although it is anticipated that institutions such as the IMF could become better regulators, it would be better if several global financial institutions were commissioned to deal with currency issues. Indeed, a regional monetary outfit would do a better job than the monopolistic IMF that seems out of sync with different economic situations across the globe.





Reference List

Aschinger, G. (2001). Why do Currency Crises arise and how could they be avoided? Intereconomics, 33 (2) 55-63.


Birdsall, N. and Fukuyama, F. (2011).New Ideas on Development after the Financial Crises, JHU, London.


Callahan, D. and Turbeville, W. (2014). Six Reasons another Financial Crisis is Inevitable, Retrieved from Accessed 20 March 2014


Jackson, J. K. (2010). Financial Crisis. DIANE Publishing, New York.


Kanaoka, M. (2013). Have the Lessons Learned from the Asia Financial Crisis been applied Effectively in Asian Economies? International Journal of Economics and Finance 4 (2): 103-110


Krugman, P. (n.d.).Currency Crises [online]; Available at Accessed 20 March 2014


Royo, S. (2010). Lessons from the Economic Crisis in Spain. Palgrave Macmillan, London.


Sergie, A. M. (2014). Currency Crises in Emerging Markets, [online]; Available at Accessed 20 March 2014


Steven, R . and Sachs, J. (1998). The Onset of the East Asian Financial Crisis, [online], Available at; Accessed 20 March 2014


Xie, Y. and Detrihhe, J. (2014). Contagion Spreads in Emerging Markets as crises Grow, [online]; Available at Retrieved from Accessed 20 March 2014

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