A currency crises arises when foreigners lose faith in
a currency and begin to sell it en-mass (a speculative attack may also
precipitate a currency crisis). The unwanted currency returns to
source and floods the country with cheap money.
The causes of a currency crisis are numerous, but
typically involves a large buildup of foreign debt obligations (often
>50% of total obligations), then an economic
downturn which prompts holders of the currency to seek the safety of
other moneys.
The results of a currency crisis are often large dislocations in an economy as
prices rise (sometimes dramatically) for both local goods and imports.
The one benefit
of a this type of economic crisis is a cheapening of export costs.
An Example: The Argentinean Currency Crisis of 2002
- Up to 2001 - An appreciating dollar (the
Argentinean peso is tied to the dollar at 1 to 1) increases the costs
of exports to such countries as Brazil. Heavy government debts
also begin to weigh upon the economy of Argentina. Large companies and wealthy
individuals sense trouble and begin to convert pesos into dollars and move the money
offshore (Argentina has had a history of currency troubles).
- Dec 1, 2001 - To prevent a run on the banks, the
government institutes the
Corralito,
essentially freezing bank accounts. People are intially able withdraw
250
pesos per week from the bank which is later upped to 300
pesos per week. Withdrawals are not
allowed from US dollar denominated accounts.
- 2001 - The Corralón is instituted in
which pesos in bank accounts are substituted with peso denominated bonds. Dollars are
substituted with pesos and peso denominated bonds.
- Late 2001 - Argentina defaults on $95 billion
of government debt.
- January 2002 - Peso devalued from 1 to 1 to 1.4
to 1.
- Early 2002 - Peso left to float freely against
the dollar and quickly drops to 4 pesos to 1 dollar.
The economy goes into a free fall.
It's important to note that the currency crisis didn't
come out of the blue, but was the result of a several years of economic
difficulties. The aftermath of the crisis was: the shutdown of the
stock market; several weeks of almost no economic activity after the
devaluation; protests & riots; the lowering
of living standards for the middle class; a dramatic increase in crime;
interruption of basic services (water, electricity, etc).
To get a better view of Argentina post crisis, read Surviving an
Economic Collapse by Fernando Ferfal Aguirre.
What Would be the Signs of an Impending
Currency Crisis?
- Companies and Individuals (most likely wealthy) begin moving money out
of the country.
- Foreigners sell US assets - i.e. US treasury bills.
- Increase in bond yields, especially for government bonds.
- Sudden decrease of the currencies' values vs. other currencies. If
the dollar index drops below 74, it's probably time to start making
preparations.
How Can You Prepare for a Currency Crisis?
- Move money into safer currencies (countries with stronger
economies and less debt).
- Precious metals retain their value.
- A currency crisis can force the rapid deterioration of economic
conditions. It's possible that there may be the interruptions
of basic services so it may not be such a bad idea to: store food & water; purchase
a water filter; purchase rechargeable batteries; etc.
How about the United States?
Although the United States is still the strongest
country in the world, it has number of weaknesses that could lead to
something akin to a currency crisis. Troubles include:
- >50 % of government debt is owned by foreigners - especially the
Chinese & Japanese.
- The economic downturn may resume.
- Extensive government budget deficits with financing moving to
the short end of the curve.
One the other hand:
- Entities that dump US dollar or dollar related assets will find
their currency appreciating against the US dollar thereby making
exports more expensive to the US (Chinese & Japanese).
- The dollar is still the reserve currency.
- The dollar is still used in the majority of international
transactions - in fact, some estimates put 70% of total US dollars
being held by foreigners.
- The dollar is still used to purchase oil in the middle east.
Additional sources
-
http://en.wikipedia.org/wiki/Argentine_economic_crisis_(1999–2002)
-
http://en.wikipedia.org/wiki/Corralito
- "Surviving the Economic Collapse" - Fernando Ferfal Aguirre
05/18/2010