Best Forex Brokers:Exchange Rate Sustainability in Forex Trading

by Wang Y. SEM

Best Forex Brokers:Exchange Rate Sustainability in Forex Trading

Within the emerging forex markets, there has been a gradual realization, particularly as barriers to trade and capital have come down, that fixed or pegged exchange rate regimes may no longer be appropriate in an economic world conquered by high capital mobility.

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Additionally, there has been an equal understanding that exchange rate pegs of one type or another unavoidably upsurge “moral hazard”, in that they are seen as an official guarantee of exchange rate stability and therefore serve to encourage the taking on of pointless and dangerous exchange rate risk.

Pegging to an international currency such as the US dollar can offer substantial monetary credibility on the one hand, but on the other the fact that US dollar interest rates are likely to be considerably lower than those in the domestic forex market can inspire domestic corporations and finance companies to borrow in the pegged currency without hedging out the currency risk rooted in those obligations.

The Asian crisis was greatly worsened by the fact that Thai, Korean and Indonesian corporations borrowed heavily in US dollars, swapped back to domestic currency and lent that out at much higher rates or used it for investment purposes.

Yet, the US dollar liability remained unhedged from a currency perspective. Consequently, when domestic currencies such as the Thai baht, Indonesian rupiah and Korean won devalued, the cost of paying those US dollar loans was multiplied proportionately in terms of the domestic currency.

In practice, many corporations were bankrupted as a direct result, while others defaulted in such debts. Gradually, emerging forex trading market countries have abandoned pegged exchange rates in favor of freely floating exchange rates, either willingly or otherwise, with this process being greatly accelerated in the wake of the emerging market crises of 1994–1999.

With this process has come the realization that “soft” or “crawling” currency pegs are no longer sustainable in a world of high capital mobility. Either exchange rates should float freely or they should be constrained by the hardest of currency pegs.

The middle ground of “intermediate” exchange rate regimes is no longer seen as tenable. This view of a “bi-polar” world of exchange rates was put most clearly and eloquently by the former IMF First Deputy Managing Director Stanley Fischer, reflecting a general move in favor of this view by the Washington official community.

In several research pieces and speeches, Fischer noted that the currency pegs have been involved in just about every emerging market crisis during the 1990s, from Mexico in 1994 through to Turkey in 2001.

Whether coincidence or not, emerging market countries that have not had pegged exchange rates have generally been able to avoid experiencing currency crises. Of the 33 leading countries classified as emerging market economies, the proportion with intermediate exchange rate regimes fell from 64% at the start of the 1990s to 42% at the end.

By 1999, 16 of these countries had freely floating exchange rates, while three had hard currency pegs in the form of a currency board or dollarization. The remainder still had intermediate exchange rate regimes.

Since then, the hollowing out of intermediate exchange rate regimes has continued, with Greece moving out of both emerging market status and a horizontal currency band into the Euro, while Turkey was forced off its crawling peg, floating its currency in the process.

This hollowing out process of intermediate exchange rate regimes has also happened with the so-called developed economies, a process dominated by the drive towards EMU and the creationof the Euro.

The ERM crises of 1992 and 1993 were initially thought to have endangered if not ended the dream of EMU. Conversely, it appears they actually served to accelerate the momentum away from such an intermediate exchange rate regime to the hardest of pegs, the single currency. By the end of 1999, all but one developed economy had either hard pegs or freely floating exchange rates, with that one exception being Denmark.

As countries move from targeting the exchange rate, through intermediate exchange rate regimes, towards freely floating exchange rates, the monetary emphasis shifts towards targeting inflation as the monetary anchor of credibility.

Whether a country chooses a hard currency peg or allows its currency to float freely may depend at least in part on its inflationary history. In theory, a hard currency peg makes sense for countries with long histories of high inflation and monetary instability.

The peg imposes a harsh policy discipline, but it also acts as a strait jacket on inflationary pressure. Even if a currency has a hard peg regime, it is also important to have an exit strategy in case of a major change (deterioration) in economic conditions which requires a similar change in the exchange rate regime.

A hard currency peg should not be seen as permanent. If a country chooses to de-peg, this is best done when the currency is under pressure to appreciate.

While this idea of a “bi-polar” world of exchange rates appeared to provide an answer to the vexing question of how countries could cope with increasingly mobile capital flow, the example of Argentina would appear to challenge this view. Not only was it the first currency board in history to be “defeated”, but this example appears to prove that even the hardest pegs could be forced to de-peg.

Certainly, the idea that a currency board cannot be defeated, once prevalent in the financial forex trading markets, has now gone. Going forward, it seems likely therefore that markets will charge a higher risk premium on currency board regimes than was previously the case as a result of this precedent.

Not only is a hard currency peg no panacea, it can also be defeated. Countries are therefore left with the question of the most appropriate exchange rate regime in the face of a global market economy consisting of high capital mobility and instant information availability.

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About Wang Y. Committed     SEM

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Joined APSense since, April 21st, 2014, From Hong Kong, China.

Created on Dec 31st 1969 18:00. Viewed 0 times.


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