A currency crisis is an economic situation where there is serious doubt as to whether or not the domestic balance of a country is adequate to support its currency. The currency crisis can be accompanied by an equally severe speculative attack on the forex market. This is usually referred to as a ‘shock therapy’ in the technical language of the trading world. This article will explore some of the implications of a currency crisis that are both economic and political.
One of the fundamental aspects of the currency crises that characterizes contemporary politics is the contraction of world trade. Between the United States, Britain and Japan in late 2021, there was a 20% loss in world trade. While some blame can be placed at the feet of certain sectors of finance like banks, governments and firms for these particular cuts, the truth is that other countries, primarily those in the developed regions, have been dealing with large-scale deflation. These countries, due to their large-scale purchases of U.S. Treasuries and U.K. Eggs, have been enjoying rapid depreciation of their currencies against the dollar. This depreciation has meant a loss in the transfer of fiscal surplus that would normally have been flowing into their respective treasuries.
This decline in world trade has, in turn, resulted in a massive contraction in gross domestic product (GDP) in the U.S., Britain and Japan. The two most affected nations, after oil, are the euro area. The result of the currency crisis has been forced internalization of the policies of the national central banks of these countries. In the U.S., the Bank of America has been forced to accept its unprecedented stimulus package, with its zero interest rates and purchases of Treasury bonds contributing to its role as the biggest lender of bank loans. Similarly, in a recent speech, the British Bank of England indicated that it is considering purchasing government bonds to raise its national currency strength to help counteract the impact of the currency crisis on the global economy.
It is highly unlikely that these two major central banks will be able to reverse their negative policies of quantitative easing or price manipulation long enough to arrest the process of depreciation. As a consequence, it is likely that the current recession will continue at least until the end of the year 2021. Moreover, even if these authorities manage to contain the negative effects of the global financial crisis on the international monetary system, they will face a difficult road ahead in overcoming the negative effects of the default crisis on their own currencies. At the present time, the possibility of a financial crisis spreading across all major economies is very high. The only way out of this predicament is for these countries to embark upon coordinated action to overcome the current recession and restore their lost credibility in the global financial markets.
However, in the past it has been argued that currency crises tend to be short-lived and will recover in a few years. More recently, the argument has been that currency crises are associated with deficient domestic monetary policy. While this argument is true in some regards, another argument is that the current level of competitiveness has been eroded by the emergence of a large number of low-income country within a relatively short period of time. While it is true that there has been a significant amount of globalization over the last twenty-five years, it is also true that the emergence of several emerging medium-sized economies has significantly reduced the barriers of trade that were once operative between countries. These countries now compete with each other in most merchandise markets, leading to the diffusion of tariffs and other protectionist measures that limit imports from the major exporting countries and have led to a sharp depreciation of the currencies of these exporting nations.
With regard to the long term impact of the crisis, there is no doubt that the current measures adopted by the governments of several countries including the US, the European Central Bank and the Japanese Bank should lead to a further strengthening of the exchange rate and facilitate a rapid recovery of the currencies of these countries. However, this will only be possible if the major international banks are able to encourage an accommodative stance on the part of the governments of these countries. This can only be facilitated if there is a loosening of fiscal policy (fiscal deflation) by the central banks of these countries. This can only be facilitated if the major national central banks continue to buy financial assets (e.g. treasuries) and credit (i.e. mortgage) securities issued by domestic financial institutions.