Currency Crises and Instability of Global Capitalism

Abstract

The chapter argues that currency crises are best explained as episodes of asset price bubbles that emerge under conditions of economic liberalization. Three destabilizing processes which correspond to different phases of an asset price bubble are underscored as general features of a currency crisis: overborrowing, overinvestment and capital flow reversals. The relative importance of these processes varies as currency crises have evolved over time. Excessive credit expansion and over-borrowing were the destabilizing processes that have played a decisive role in current account driven crises, where capital inflow was predominantly governed by arbitrage opportunities and its reversal tied to rising devaluation risk associated with reserve depletion. Starting with the late 1980s, capital account driven crises have come to predominate as variable price assets, such as bonds and stocks, as opposed to fixed price assets in the form bank loans, became the main conduits of the capital inflow. In these crises, portfolio dynamics driven by speculative expectations on variable price assets, along with the increased predictability of asset prices, set the stage for destabilizing trend speculation on the part of international investors. Foreign investors chased a rising trend of asset prices, and capital flow reversed when they begin to think that asset prices have peaked.KeywordsInterest RateAsset PriceCapital FlowCapital InflowCurrent Account DeficitThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.