Institutional investors and Polanyi's double movement: a model of contemporary currency crises

Abstract

This article constructs a model of contemporary currency crises which incorporates the role played by institutional investors and the dynamics associated with Karl Polanyi's notion of the 'double movement'. Polanyi's double movement, and its recognition of the need to integrate politics with economics, is used to explain why so many governments are prone to pursue policies that lead to a speculative attack against fixed exchange rates and why virtually every modern fixed exchange rate regime has ended in crisis. Evidence on the short-term and herd behaviour of institutional investors is used to explain why contemporary currency crises do not appear to be justified by underlying economic fundamentals and why these crises do so much more damage than their earlier counterparts. The model is then applied to the 1992 European Exchange Rate Mechanism crisis, the 1994 Mexican peso crisis and the 1997 East Asian crisis. While recognizing that variations exist in the specific circumstances of each episode, the argument of this article is that the progression of events do seem to conform to the model presented.