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The Main Causes Of Crisis Currency
Many international financiers have always been forced to into runs on currencies or even capital flight doe to unexpected crisis currency. The main cause is normally unpreparedness from those who have invested heavily in a country. Although most of the causes can be detected before the situation begins, others are unforeseeable. You will find some of the factors that lead to this financial condition and how financiers can deal with the circumstances.
The problem normally begins when a country introduces a peg. Most developing countries that suffer from financial instabilities like budget deficits and excessive inflation are the common culprits. In a response to bring the situation under control, the country may have to use a reserve currency to protect its legal tender. Although this may stabilize the domestic economy, the over-reliance on foreign exchange by investors can be disastrous.
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.
There is also the danger of moral hazard. Liquidity in the financial market causes local banks to ease their conditions for giving out loans. This is because they are protected from losses by hidden government guarantees. This way, they would result with immense profits in the event that the balance favors them, but the taxpayers will shield the burden in case of losses.
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.
Sometimes, the problem does not even start in the financial sectors. Conditions such as political unrest, a current recession, new policies, and lack of regulative measures in a highly liberal market may cause investors to doubt if the country is credit worthy. These factors will lead to withdrawal, which may lead to economic collapse and eventual financial distress.
Corruption and nepotism are also major problems, especially in developing countries. The country may not be able to access foreign investment alternatives that are more stable. As a result, it may be forced to seek the volatile foreign credits. This may save the situation but will take a toll on the domestic capital.
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 problem normally begins when a country introduces a peg. Most developing countries that suffer from financial instabilities like budget deficits and excessive inflation are the common culprits. In a response to bring the situation under control, the country may have to use a reserve currency to protect its legal tender. Although this may stabilize the domestic economy, the over-reliance on foreign exchange by investors can be disastrous.
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.
There is also the danger of moral hazard. Liquidity in the financial market causes local banks to ease their conditions for giving out loans. This is because they are protected from losses by hidden government guarantees. This way, they would result with immense profits in the event that the balance favors them, but the taxpayers will shield the burden in case of losses.
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.
Sometimes, the problem does not even start in the financial sectors. Conditions such as political unrest, a current recession, new policies, and lack of regulative measures in a highly liberal market may cause investors to doubt if the country is credit worthy. These factors will lead to withdrawal, which may lead to economic collapse and eventual financial distress.
Corruption and nepotism are also major problems, especially in developing countries. The country may not be able to access foreign investment alternatives that are more stable. As a result, it may be forced to seek the volatile foreign credits. This may save the situation but will take a toll on the domestic capital.
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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