Currency Wars: “Beggar Thy Neighbor” Policy
February 12, 2025
Financial modeling has become an essential part of most real estate transactions today. This is because of the fact that real estate deals today are complex are undertaken not only by individuals but by corporations who specialize in such transactions. Take the case of Real Estate Investment Trusts (REITs), for example. These trusts are organizations […]
What is a Security ? Assets with some financial value are called securities. Characteristics of Securities Securities are tradable and represent a financial value. Securities are fungible. Classification of Securities Debt Securities: Tradable assets which have clearly defined terms and conditions are called debt securities. Financial instruments sold and purchased between parties with clearly mentioned […]
There are two predominant schools of thought about the stock market. The views of these schools of thought are somewhat contradictory. There is one school of thought which advises investors to stay away from stock market investments since they are inherently volatile. You will often see people who believe in this school of thought advocating […]
Debt and equity from investors remain the two conservative sources of funding when it comes to infrastructure financing. However, with the advent of time and financial innovation, newer sources of funding have now become available. Vendor financing is one such mode of funding which is now being widely used in infrastructure projects. The concept of […]
In the past module, we concentrated on calculating the returns part of the project. All our articles were focused on calculating cash flows and we saw the various special cases that arise while determining cash flows and determined how we must deal with them. This module is all about the other component i.e. risk. The […]
Currency pegs have become extremely popular in the post Bretton Woods monetary world. About one fourth of all countries in the world today have pegged their currencies to some other major currency like the dollar or the euro.
This strategy has bankrupted certain nations like Argentina whereas it has caused other nations like China to reach economic success. Therefore, this strategy has certain advantages as well as certain disadvantages. In this article, we will list down both the advantages as well as disadvantages.
However, the issue remains the same regardless of whether the Dollar is used or the Euro. The government has to convert its own currency to another one at the Forex market. If the rates are constantly fluctuating, the government cannot anticipate how much of its own currency will it require so that it can convert it to foreign currency and meet the demand. On the other hand, currency pegs fix the rate and provide a stable basis for governments to plan their revenues and expenditures in local currencies without any concerns about the volatile rates.
Hence, such countries want to outsource their monetary policy to a more developed nation where the policymakers would take more responsible decisions. This only partially offsets the threat of sabotage from local politicians. This is because politicians can still order printing of money and cause inflation. However, they cannot reduce interest rates and cause a bubble in the economy in general when a currency peg is being followed.
Consider the case of the attack on the Pound Sterling. During that time the British government had pegged its currency to the German Deutschemark. German Bundesbank increased the interest rates because of domestic concerns on inflation.
The British wanted the interest rates to fall. However, there was no drop in the rates. As such, the British pound took a severe beating because the Bank of England was no longer in control of its affairs and the Bundesbank had an increased influence in Britain’s domestic affairs.
Hence, increasing imports automatically lead to a situation of increasing exports! The freely floating system tends towards equilibrium. However, currency pegs tend to exaggerate disequilibrium.
Consider the case of the massive trade and current account deficits between United States and China and the fact that at the root cause, they have been caused by a peg between the dollar and the Yuan. Therefore, currencies that have pegs with other currencies are prone to disequilibrium. This has happened several times in the short economic history of freely floating currencies and is expected to happen several more times in the future.
There are some financial funds with deep pockets that can even take on Central Banks and such cases have happened several times. When currencies have ventured too far from their fundamental value, speculators have been able to force devaluations on such currencies.
Also, sometimes the speculative attacks are so severe that countries have to abandon the pegs and allow their currencies to freely float within a couple of days. Whenever such an attack occurs, the common man of the country suffers increased losses since foreign trade as well as foreign investments face a massive impact.
A currency which is already freely floating is at a much lower risk of such an attack. Hence, this can be considered to be a major disadvantage of currency pegs.
Your email address will not be published. Required fields are marked *