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Why is it Difficult to Raise Seed Funding?
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Extrapolation: The Root Cause behind the Bubbles
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Was The Silicon Valley Bank Bailed Out by the Government?
The current crisis at the Silicon Valley Bank is a stark reminder of the dark days of 2008. Just like now, the entire banking system was in complete disarray. However, during that time, the government created the Troubled Asset Relief Program (TARP) which was commonly known as the bailout. After 2008, the government as well […]
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.
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