A currency crisis occurs when a currency goes through sudden volatility that causes speculation in the Forex market. Some elements can trigger this crisis, such as monetary policy decisions and currency pegs.
A central bank itself or even pure speculation can trigger a currency crisis. Factors that cause a currency crisis can be challenging to predict in advance.
In the past, the leading cause of a currency crisis is the central bank’s failure to hold a fixed-rate peg to a floating rate foreign currency. Also, it can stem from the central bank’s actions to prop up its currency value to maintain investment capitals within its limits.
There are cases when countries plan to keep their currency artificially low to increase the demand for their exports.
The Solution
Just like other crises, the existence of a currency crisis can be tamed or solved. There are preventative measures countries can implement to prevent this crisis from happening. The best solution is to avoid it in the first place by applying a floating exchange rate. This makes sure that the market is always setting the price. It is a complete turnaround from fixed exchange rates where central banks must go against the market.
Central banks should also make it a point to avoid monetary policies that involve trading against the market, and only implement it when there is a need to prevent a broader crisis.
Lessons Investors Should Learn
Investors should be mindful of currency dynamics when making their investment decisions. There are significant problems that are predictable because they can manifest to some extent. Currency imbalances can be a miracle in disguise because it can offer opportunities in hedging a portfolio against risk.
Also read: Currency Devaluation Is Not the Solution for Country Economy
