The emerging currency crisis in the new world order!

We are aware of numerous currency crises since the early 1990s due to unforeseen fluctuations in exchange rates. Currency disorders are predictable, but most of them happen suddenly. Moreover, a currency crisis involves a steep decline in a nation’s currency value. Therefore, governments and central banks sell off gold and foreign currencies to enhance stability. 

In today’s day and age, market investors from across the globe are trying to figure out if the hikes in interest rates can further lead to recession. More importantly, with the erosion of an economy’s stability, investors tend to withdraw a significant amount of money. Such an event is described as capital flight and worsens foreign exchange rates. 

However, certain factors can have a significant impact on currency exchange rates,

• Inflation 

• Correlation of interest rates and exchange rates

• Public debt 

• Lack of capital inflow in financing current account deficit 

As the first line of defense to maintain a currency’s stability, central banks can dip into the nation’s foreign reserves and utilize foreign exchange markets. When a bank sells foreign funds, the payments happen in domestic currency. Later, central banks can hold that money out of circulation to convert it into an asset for future currency disorders. 

“When you have an environment where the U.S. dollar is strengthening, U.S. front-end rates are going up. It tightens external financial conditions for emerging markets, especially for the deficit economies,” Murat Ulgen, global head of emerging markets research at HSBC.

More importantly, many market investors have worried about how they can turn the tides towards some benefits over the years.

• Overseas investments 

• Investing in U.S. multinational organizations

• Avoid borrowing foreign currencies at low-interest rates. 

Long story short, even making unprecedented currency moves can significantly impact the domestic and global economy. 

More importantly, in today’s day and age, only four substitute currencies can be feasible in terms of globalized national currencies: 

• Private currencies like Bitcoin

• Commodity money like gold

• Global fiat money 

Although, another national currency like China’s would be admissible in replacing global foreign reserves. However, China is still developing a financial system, and its currency is still not fully convertible. Perhaps, the current world scenario states that no global money has attained sufficient weight to replace reserves.

Therefore, the lack of any credible substitute shows that the U.S. and its allies dominate the world’s currency. Such significant dominance of U.S. dollars in the global monetary functions is a byproduct of the country’s economic size and financial markets. 

Bottom line,

Today’s emerging currency disorders are a byproduct of increasing currency value, current account deficits, and even uncertainty of government actions causing capital flights. 

Furthermore, an economy can remain stable initially yet suddenly succumb to currency disorders. After all, maintaining and sustaining fixed exchange rates is not enough to stabilize the downfall of an economy. However, low inflation and trade surpluses can help reduce currency disorders' impact on the overall economy. 

Perhaps, optimal management strategies implemented by the central banks can predict which way the current currency crisis is leading the economy, along with contributing towards sustaining the emergence of currency disorders.