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BMC-module-2-3-notes-currency-regulation.txt
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3:34 PM 8/20/2024
BMC 2.3: Currency Regulation and Control
Two types:
individual behavior+ethics regulations,
government/centralbank regulation
e.g. fixed/pegged currencies, cryptocurrency regulation
An "open economy" has more imports and exports,
but has higher risk of disruption due to currency fluctuations
Net exporters have an incentive to weaken their currency
Net importers have an incentive to strengthen their currency
Bloomber Terminal -> ECTR [ can see which countries are major trading parters over time ]
Budget deficit: spend > receive
Budget surprlus: spend < receive
If a country wants to run a budget deficit and finance this by borrowing from international investors
by issuing bonds in its own currency, then weakness in this country's own currency
may deter investors from buying more bonds as they would face a loss on these assets
If a govt instead issues bonds in foreign currencies, then weakness in its own currency
can dramatically increase the cost of repaying their debt in the foreign currency
In most cases, governments aim to manage the overall trend and volatility in their currency's value
A government may want to weaken its currency to increase the cost of imports and protect domestic industries.
------------
Central banks may intervene to maintain specific exchange rate policies:
- Bank of England 1992
- Swiss National Bank 2015
Successful intervention [example hong kong] and failed intervention [example argentina]
China may be manipulating their currency to maintain competitiveness of chinese exports
Bloomberg: -> NI CEN -> news topics: central banks
-------------
Main methods for a central bank to control the FX market:
1. Direct intervention
a central bank buys (or sells) its own currency in order to raise (or lower) its value
-> when it buys its own currency, it sells some of its reserves (held in foreign currencies)
-> Bloomberg: BI CURRG -> FX Macro -> Reserves/Import Cover
[countries are ranked by the size of their reserves in USD over time]
2. Verbal intervention
a warning by a central bank to market participants that it might intervene directly
-> may be sufficient if the "threat" of direct intervention is credible
3. Interest rate intervention
central banks can adjust their official short-term interest rates as a means of currency intervention
-> most commonly, tightening monetary policy (raising interest rates) prevents currency weakness
Whether these interventions are credible depends on a few questions:
Does the central bank have sufficient foreign exchange reserves to continue buying its own currency?
Has the central bank previously been successful or not when carrying out such interventions?
Would a change in interest rates conflict with the country's underlying economic position/policy?\
Could this also raise doubts about the political will/ability to sacrifice short-term economic
benefits for the sake of establishing credibility and stability in foreign exchange policy? [??]
Lack of credibility in a central bank's intervention can make matters worse.
---------------------
1979 ERM [European Exchange Rate Mechanism] (part of EMS [European Monetary System])
1990 UK joins ERM
1999 introduction of Euro and ERM II (European Exchange Rate Mechanism II)
2011-2012 Eurozone Sofvereign Debt Crisis
Investors sold the bonds of govts with large fiscal deficits [?]
e.g. Portugal, Italy, Ireland, Greece, Spain
This extended to flight out of Euro and into Swiss Franc
Four examples of Central Bank Interventions:
1. Bank of England 1992
UK needed strength in Sterling vs DM to maintain membership in ERM
UK had economic recession -> for this they needed to maintain low interest rate,
and weakness in Sterling, in order to sustain exports
George Soros expected that the economic necessity would win out
This reflected a general lack of credibility for the Bank of England's ability to maintain the value of GBP
UK raised interest rates [peaked at 15% on Sept 16 1992], but had to leave the ERM
Bloomberg -> GBPDEM CURNCY GPC [Candle Chart] -> change dates to 06/01/1992-01/01/1993
This was a good example of a failed central bank intervention.
2. Swiss National Bank 2015
In 2012 the Swiss National Bank announced that it would prevent extended Franc strength by imposing a floor at 1.200
[vs. DM]
This was successful as investors had strong confidence in the Swiss National Bank
On Jan 15th 2015 the SNB suddenly announced it would no longer impose this floor
There was a dramatic and abrupt reaction
WIthin minutes, EUR/CHF fell to 0.85 within minutes
The SNB was widely criticized for not providing any warning to investors
Bloomberg -> EURCHF CURNCY GPC W -> change dates to01/01/2010-01/01/2016
3. Hong Kong Monetary Authority 1997-1998
Established in 1983
HKMA has substantial foreign currency reserves
These reserves help to maintain credibility that pegged HKD/USD 7.80 will be maintained
1997 Asian Financial Crisis
HKMA threatened penalty charges on institutions which borrowed HKD to lend on to speculators wishing to sell
This allowed the 7.80 HKD/USD peg to be maintained
Similar episode occurred in 1998, this time bolder strategy:
HKMA bought HKD, spent 15bn USD on buying Hong Kong equities
This allowed the HKMA to:
- maintain the pegged exchange rate
- generate profits on intervention purchases
- reinforce their credibility
The current range is 7.75 - 7.85, which it still maintains
The 7.80 peg was maintained both in 1997 and 1998
This can't be seen on charts of spot fx prices, but evident in HKD interest rates
Bloomberg -> HKD12M CURNCY GPO M -> set dates to include 1997 and 1998
4. Argentina 2001-2002
Since 1980, Argentina has defaulted on its foreign currency debt five times
Argentina is currently the largest single debtor of the IMF
IMF = main international lender
Inflation was 3000-5000% in 1989 and remains volatile.
Official methods to measure inflation have changed over the years:
Bloomberg -> ECST [World Economic Statistics] -> Type Argentina ->
-> Prices+ConsumerPrices -> Transformation:YoY% -> Chart:ARNCYINX -> Maximize chart
1991: Convertibility Plan to counter hyperinflation + liberalize foreign trade + increase productivity/growth
- USD/ARS PEG at 1.00, maintained by foreign currency inflows by state borrowing, and by privatizing state-owned companies
- Peg introduced by law, making subsequent changes more difficult
- This was generally successful until 1998
[1997 Asian Currency Crisis]
[1998 Russia's default on debt]
[1999 BRL devaluation by 35% -> makes argentine agricultural exports uncompetitive]
[1999 Global agricultural prices fall]
[general USD strengthening, which means the peg makes argentine
- no "lender of last resort" [?]
- bank run 2001, argentina freezes bank accounts, IMF withdraws support
- 2001: Dec 26th, 93 billion default = world's biggest ever bond default
- 2002: peg changed from 1.00 to 1.40