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The Causes Of Crisis Currency Instabilities

By Lela Perkins

From the early 1990s, numerous cases have been reported of currencies investors being caught pants down resulting in runs on currencies together with capital flight. Some may ask themselves what drives these investors and international financiers to consider capital flight. Some of the reasons include going by their gut instinct or by evaluating economy minutia. Below is a look at causes and effects of crisis currency instability.

A decline in the value of a certain nations currencies is the main factor causing currencies crisis. The value decline affects the economy in bad way, leading to instability in exchange rates, as the units of such currencies do not sell as much as observed earlier in others. In simple terms, a crisis of such nature takes place as an interface between what investors expect and how they deal with the expectations.

When a potential crisis is on the verge of happening, central banks in affixed exchange rate economy can try to maintain the current rate by tapping into the country’s foreign reserves, or by letting the exchange rate to undergo fluctuations. Investors may wonder how eating into foreign reserves may offer a solution. When the markets expect devaluation, offsetting the pressure set on the currencies can only be done by an increment in the interest rates.

In order to increase the rates, the central bank has to shrink the supply of money, causing an increase in demand for the currencies. This can be achieved by selling off foreign reserves in order to form an outflow of capital. When central banks sell a segment of their foreign reserves, the payment is received in form of domestic currency that it will keep out of circulation as an asset.

Dipping of the exchange rate cant go on forever, den to declines of foreign reserves as well as political or economic factors like low levels of employment. Currencies devaluations by raising fixed exchange rates causes domestic goods to be sold cheaply than foreign products.

This in turn increases output by boosting demand for workers. Devaluation can also increase interest rates in the short run, which the central bank must offset by an increase in the money supply and foreign reserves.

Investors know that devaluation strategies can be utilized, something that they take advantage of to meet their expectations, some that favors citizens but is unfortunate for banks. If a market anticipates currencies devaluation by central banks, the exchange rate would be raised, while the chances of an aggregate demand may not be met. What the central banks can instead do is to shrink the money supply by utilization of its reserves, later increasing the rate of domestic interests.

In case investor confidence in economic stability is eroded, they might attempt capital flight, whereby they get the money outside their country. When such investors market their investments, the investments are converted in currencies of other countries. This is not good for exchange rates. All in all, a prediction of when a certain country will have a crisis currency instability includes a number of complex variables.

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Article Citation
MLA Style Citation:
Perkins, Lela "The Causes Of Crisis Currency Instabilities." The Causes Of Crisis Currency Instabilities. 17 Apr. 2014. uberarticles.com. 31 Jul 2014 <http://uberarticles.com/finance/currency-trading/the-causes-of-crisis-currency-instabilities/>.

APA Style Citation:
Perkins, L (2014, April 17). The Causes Of Crisis Currency Instabilities. Retrieved July 31, 2014, from http://uberarticles.com/finance/currency-trading/the-causes-of-crisis-currency-instabilities/

Chicago Style Citation:
Perkins, Lela "The Causes Of Crisis Currency Instabilities" uberarticles.com. http://uberarticles.com/finance/currency-trading/the-causes-of-crisis-currency-instabilities/


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