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Currency pegs can play a big part in forex trading by artificially stemming volatility. Thai markets began the new year with a hangover as the Thai baht crumbled to a record low onshore and the stock market took another pounding.
Arguably, the most infamous example of a recent fixed-exchange rate is the Thai baht, given that the government's decision to de-peg it from the dollar precipitated the Asian financial crisis in the late s. Thailand was a star performer from the mids to The economy grew within a range of 8. But things started to slow down around , which then put some pressure on the government to devalue the currency. It resisted for some time, but when investors started betting that the currency would lose value in , this prompted the Bank of Thailand to spend billions of dollars of its limited foreign reserves defending its currency.
Eventually, the BoT had to abandon the peg on July 2, Employees of suspended finance companies during a rally outside the Bank of Thailand in Bangkok on November Hundreds of disgruntled employees who were either laid off or about to lose their jobs urged the central bank to take responsibility for their plight.
Operations in 58 of the country's 91 finance companies were suspended. The depreciation of the baht was followed by a chain reaction of people speculating against other Southeast Asian currencies, including the Malaysian ringgit, the Philippine peso, and the Indonesian rupiah.
And then, in , it spilled into Russia and Brazil. In , prices in Argentina were rising so quickly that supermarkets didn't even bother to update price tags. Instead, they just read out the prices over intercoms, according to Reuters. That's how insane Argentina's hyperinflation was from in the late s to the early s. Argentines took to the streets to protest the soaring prices. In Buenos Aires, "bands of angry youths, armed with sticks, steel bars and in some cases firearms, roamed poor neighborhoods burning tires, battling the police and looting food stores," reported James Brooke in The New York Times on May 31, Trading Economics.
Domingo Cavallo was the guy who had to try to solve this. As minister of the economy in , he came up with a plan known as "Covertibilidad" — or "convertibility.
But, eventually, Argentina ended up running into the negative effects of having a fixed-exchange rate. Unemployed Argentines demand food at the gate of a supermarket on the outskirts of Buenos Aires on December 19, Police in riot gear fired tear gas and rubber bullets to disperse looters who ransacked shops and supermarkets in the capital and northern part of the country, in some of the worst rioting in more than a decade.
This was evident when the Asian financial crisis bled into Brazil, and the Brazilian real plunged. The peso, still linked to the dollar, did not. This left Argentine exports significantly more expensive relative to those of Brazil, taking a toll on Argentina's economy and making it harder for the government to repay its debts.
And "a decline in world prices for farm product, and the global economic slowdown of recent months, only worsened Argentina's problems.
Although one might think that devaluing the currency would solve the export problem, Argentina's other issues made this a difficult choice. As The Economist explained in June :.
Less than a tenth of the government's debt is denominated in pesos, so devaluation would bring financial ruin to it as well as to private-sector borrowers. But the shadow of a potentially catastrophic default still hangs over Argentina. And so, things got worse. Riots escalated across the country in response in December Argentine demonstrators place tires to block a main avenue to protest unpopular new banking curbs, soaring unemployment, and economic austerity measures in Buenos Aires on December 14, The fixed exchange rate dynamic not only adds to a company's earnings outlook, it also supports a rising standard of living and overall economic growth.
But that's not all. Governments that have sided with the idea of a fixed, or pegged, exchange rate are looking to protect their domestic economies. Foreign exchange swings have been known to adversely affect an economy and its growth outlook. And, by shielding the domestic currency from volatile swings, governments can reduce the likelihood of a currency crisis.
After a short couple of years with a semi-floated currency, China decided during the global financial crisis of to revert back to a fixed exchange rate regime. The decision helped the Chinese economy to emerge two years later relatively unscathed.
Meanwhile, other global industrialized economies that didn't have such a policy turned lower before rebounding. There are downsides to fixed currencies, as there is a price that governments pay when implementing the pegged-currency policy in their countries. A common element with all fixed or pegged foreign exchange regimes is the need to maintain the fixed exchange rate. This requires large amounts of reserves, as the country's government or central bank is constantly buying or selling the domestic currency.
China is a perfect example. Before repealing the fixed-rate scheme in , Chinese foreign exchange reserves grew significantly each year in order to maintain the U. The pace of growth in reserves was so rapid it took China only a couple of years to overshadow Japan's foreign exchange reserves.
The problem with huge currency reserves is that the massive amount of funds or capital that is being created can create unwanted economic side effects —namely higher inflation. The more currency reserves there are, the bigger the monetary supply , which causes prices to rise. Rising prices can cause havoc for countries that are looking to keep things stable. These types of economic elements have caused many fixed exchange rate regimes to fail.
Although these economies are able to defend themselves against adverse global situations, they tend to be exposed domestically. Many times, indecision about adjusting the peg for an economy's currency can be coupled with the inability to defend the underlying fixed rate. The Thai baht was one such currency. The baht was at one time pegged to the U. Once considered a prized currency investment, the Thai baht came under attack following adverse capital market events during The currency depreciated and the baht plunged rapidly, because the government was unwilling and unable to defend the baht peg using limited reserves.
In July , the Thai government was forced into floating the currency before accepting an International Monetary Fund bailout. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.
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