Foreign Exchange: A Practical Guide to the FX Markets

CHAPTER 12

Currency Crises

When the Bretton Woods system of fixed exchange rates broke up in the early 1970s, most international economists were not dismayed. Not only did they believe that greater flexibility of exchange rates was a good thing; they also believed that they understood reasonably well how the new system would work. They were wrong. The last 20 years of the international monetary unpleasant, all of them forcing economists to scramble to keep up with new issues and unexpected turns in old ones.

—Paul R. Krugman in Currencies and Crises (1998)

 

 

 

Since money has been used, there have been occasional crises. After all, money is a matter of faith, and faith has been known to waver.

When most of us think of a crisis or crash, we tend to think of a spectacularly dramatic fall in the stock market (i.e., a large and general drop in stock prices across the board). Less intuitive, though no less painful, are the similarly high profile spikes or upward jumps in commodity prices (oil, gold, orange juice). It has been said that equities tend to crash down; commodities tend to crash up. Where is foreign exchange in all this? Interestingly, if one currency crashes down, its counterpart must be skyrocketing (in relative terms). Unlike the case of equities where a substantial decline is painful to everybody (after all, “the world is long stock”), significant movements in foreign exchange rates serve to benefit some and inflict pain on others.

Charles P. Kindleberger tells us, “A ...