Ever wondered how the currency jumps on certain days even though there aren’t any significant events or data released? The foreign exchange market has huge volumes thanks to the currency traders rather than the exporters or importers who want to convert their payables or receivables.
Most traders believe a particular trend in which a currency pair will move and take positions accordingly. Assuming these are well informed and forex educated traders, there are bound to be stop loss levels in place. But ever so often, we see traders who believe the value of one currency is over-valued against the other and thus sell that currency expecting a fall in it. Simultaneously they also buy another currency. Thus making profit by seeing upward potential in the currency they purchase.
When the currency of a country is fixed or pegged, then the speculators who attempt to manipulate the market may succeed if the respective central bank doesn’t have enough forex reserves to purchase its domestic currency. Thus the pegged currency may not hold all together.
Black Wednesday in 1992
Most of us have heard of the Black Wednesday in UK when there was a speculative currency attack by George Soros on September 16, 1992 on Bank of England. That was the time when Pound was semi-pegged as it was under the European Exchange Rate Mechanism (ERM) wherein the currency could move within a 6% in either direction – thus central bank intervened to keep a check on its movements with counter trades. George Soros short sold more than $10 million worth of Pound which prompted Bank of England to buy £1 billion worth of its own currency within two hours of the market opening on Wednesday. This prompted the Bank to raise interest rates from 2% to 5% in one day in order to resolve the currency attack attracting the pound, but that too didn’t work and finally the Bank of England withdrew from the ERM to let the market revalue the pound to lower levels which were more appropriate.
Black Thursday in 1997
A similar attack happened on October 23, 1997 with Hong Kong Dollar wherein the interbank interest rate rose to triple digits and monthly interest rate rose to 50%. Though it settled the currency initially, but later in 1998 further attacks with high interest rates took a toll on the Hong Kong Dollar. This was along with the devaluation of Thai Baht as Thai government was unable to support the pegged currency to the dollar due to lack of forex reserves. After Hong Kong sourced large amounts of money from China, the central bank successfully defended the attack. These currency attacks led to the 1997 Asian financial crisis.
Learning from Speculative Currency attacks
The central bank cannot always manage the currency attack through interest rates by increasing them to a great extent which becomes an expensive endeavor – often futile. Since governments have chosen to stay with a pegged/semi pegged policy, they may not always be right. Loopholes prevail which are awaited by many currency attackers. But at the same time, the government stepped in at the right time (even though temporarily) shows the potential to resolve the issue at their end.
Thus central banks can understand such issues and avoid future crisis caused due to regulatory constraints.
08 May 2020 05:21 PM
Converting one exchange rate into another at a particular price makes transferring rates. Ideally all nations should be treated as equal and there shouldn’t be any exchange rate applicable which would mean to have a universal currency.
24 Apr 2020 03:08 PM
Managing risk in a financial market is required to keep a check on the adverse movements in the instrument of the market. Particularly in the foreign exchange market.
10 Apr 2020 06:12 PM
So was India’s decision on locking down the country for 21 days required? The implication on the economic growth or rather slowdown has only made many doubt the timing and preparedness of the decision.
24 Feb 2020 05:08 PM
When they say the currency markets are volatile, it is the spot exchange rate, which is being referred to, which fluctuates within seconds.
07 Feb 2020 03:19 PM
Derivatives market enables access to financial assets for trading at a future date and not just at the market trading date. In currency derivatives the trader agrees to buy or sell a fixed amount of a specified currency at the end.
27 Jan 2020 02:13 PM
Well devaluing a currency can give a thrust to the exports and reduce the trade deficit but for any economy which has higher imports, the consequences can be on the negative too.