The Currency Origins of Financial Crises
The Currency Origins of Financial Crises
This chapter analyzes how currency risk has been the fundamental cause of all the financial crises in developing countries, and discusses how, in all such crises, the trigger has been a currency run associated with a cycle of currency appreciation and depreciation. During these cycles, the prices of nontradables increased quickly relative to those of the tradables, leading to a boom in nontradable asset prices. Then, the prices of these assets fell, leading to a bust. The change in the direction of the shifts in relative prices has triggered a currency run, which has forced the devaluation of the currency. This, in turn, has worsened the speed of the collapse of the prices of assets. The chapter reveals that while currency runs create liquidity crises in the banks, the violent shifts in relative prices have a negative impact on the solvency of the banks.
Keywords: currency risk, developing countries, currency appreciation, depreciation, devaluation
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