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Currency Crises 3 Case Studies: Europe Exchange Rate Mechanism (1992), Asia (1995) And Argentina (2002)

1766 words - 7 pages

Case study 1: the ERM crises of 1992-3Put simply, as a precursor to full monetary union (the euro), the economies of the EU undertook a period of exchange rate management in order to create convergence and stability before full conversion to the euro. This took the form of the Exchange Rate Mechanism (ERM). It was a hybrid of fixed and floating exchange rates where currencies were allowed to float against each other but within a pre determined band. If currencies moved to the top or bottom of the band, the central banks were committed to intervene in the markets to stay within the band.The UK was a late member of the ERM, though it had for some years pursued a policy of shadowing the DM. This was because the DM was seen as the strongest and most stable currency in Europe. It would instil in the UK financial discipline, particularly in inflation. When the UK entered the ERM IN 1990, the ERM was regarded by existing members as a great success, policies had converged and inflation had generally been brought under control.However,1. The removal of capital controls in 1991 made currencies vulnerable to speculative attack.2. The German economy as under strain from unification. The budget deficit was growing rapidly, therefore to keep inflation down, the Bundesbank kept interest rates high.3. The UK entered the ERM at a rate many thought was unsustainably high. As th UK slid into recession, it was obliged to keep interest rates high to support the pound.4. The US economy went into recession and interest were cut. Capital found its way to high interest rate countries, notably Germany, pushing the DM higher.Tensions grew and in September 1992, the Italian Lira was devalued. Two days later (Black Wednesday) 16th September, The UK and Italy were forced to suspend their membership.In the summer of 1993 a second wave of attacks led to a decision to widen the exchange rate bands of that system, essentially to allow the French franc to depreciate without any formal exit. In subsequent years events have unfolded in somewhat ironic ways: France, having been given leeway for a somewhat weaker franc, chose not to use it, returning to the original narrow band against the mark; while the boom in the UK economy that followed the exit from the ERM has now pushed the pound above the rate at which it originally exited. Still, the ERM crisis remains one of the classic episodes of speculative attack, and is the most thoroughly studied such episode.All the ingredients for crisis, then, were in place. However, four special aspects of the ERM crises should be noted.First was the role of a large actor - George Soros - in triggering the crisis. Soros had divined early in the game the possibility of a sterling devaluation, and set about discreetly establishing a short position in the form of a number of short-term credit lines, totalling approximately $15 billion. He was thus in a position to profit from a collapse of the exchange regime, and did in fact attempt by his own sales...

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