Currency Wars: “Beggar Thy Neighbor” Policy
February 12, 2025
The discipline of economics is generally valid for all industries across the world. This is because the basic fundamental economic principles of demand, supply, and free market are applicable to almost all industries in the world. There are only a few industries where these economic principles are not really applicable. The sporting industry is one […]
Just like we have the single stage Free Cash Flow to the Firm (FCFF) model, we also have the Free Cash Flow to Equity model. This model also is not used by analysts in advanced calculations. Rather it is used for the most rudimentary back of the envelope calculations for deriving the equity valuation of […]
The financial services industry can be divided into two sectors viz, the retail and the wholesale sector. On one hand, there is the retail sector, which provides a wide variety of deposit-taking and loan-related financial services to the common people. On the other hand, there is the wholesale sector that provides services to institutions. These […]
Infrastructure projects are most needed in developing nations. These are the countries where infrastructure projects are able to create the most growth. This is because the spillover effects of infrastructure projects are felt significantly in emerging markets. Ideally, emerging markets should create policies that attract more and more foreign investment on to their shores. However, […]
Sporting franchises across the world have traditionally been owned by wealthy individuals. This has largely been because of the fact that sporting franchises have been viewed less as financially viable investments and more as vanity toys. However, all this has started changing in the wake of stellar returns provided by sporting franchises in the recent […]
Central Banks do not intervene often in the Forex market. In fact, the intervention by Central Banks can be considered to be a sign of significant economic weakness in a currency. As a result, Central Bank intervention usually only happens when the currency is under some sort of crisis. This could be a genuine economic crisis like the 2008 crisis or the Euro crisis. Alternatively, it could also be a speculative attack that a country is facing.
There are multiple ways in which Central Banks can intervene in the markets. Some of these ways require more commitment than the others and are also more effective than the others. In this article, we have listed down the 4 prominent types of Central Bank interventions.
The traders and other participants in the market are aware of the monetary might of the Central Banks and therefore more often than not, the currency range declared by the Central Bank becomes the range in which the currency automatically starts trading without any Central Bank intervention.
Jawboning is essentially a technique where the threat of a Central Bank intervention to reset the rates is used to reset the rates without the intervention ever taking place! Jawboning is particularly effective when Central Banks have the reputation for periodic intervention into the open markets.
Concerted intervention only takes place when many Central Banks share the same objective i.e. they want to control a particular exchange rate. Usually jawboning from all Central Banks gets the desired results. One or two Central Banks may actually have to intervene. However, only in the rarest of the rare cases do multiple Central Banks have to conduct operational interventions to correct a currency rate.
Let’s understand this with the help of an example. Let’s say that the Fed is concerned about the dollar depreciation against the Indian rupee and wants to take action to change this. In this case, the Fed will sell Indian rupee in the market and buy dollars from it. This will lead to two effects. Firstly, it will increase the supply of the rupee and secondly it will decrease the supply of the dollars. The objective of the Fed in the Forex market will be fulfilled.
However, there is also a side effect to this policy. The number of dollars in the United States economy would suddenly increase as a result of this transaction. This could cause inflation and other economic issues as well. Therefore, to counter the situation, the Fed would sell United States denominated bonds in the market. As a result, it will remove dollars from the domestic market (sterilizing the effect). The dollars will now be replaced with the government obligation and therefore the inflation and other effects will be controlled.
Your email address will not be published. Required fields are marked *