Saturday, 12 November 2016

Currency speculation takes on a life of its own in a floating exchange system.

A floating exchange rate system is based on the notion that market forces, as opposed to government policy, determine currency exchange.

Buyers and sellers of a currency determine the price.

Buyers and sellers can include

  • traders, 
  • fund managers, 
  • banks, 
  • multinational corporations and 
  • governments.

Although a floating system leaves the process of determining exchange rates to market forces, those forces can force a currency to collapse.

If a major fund assumes a short position in a particular currency, it can push that currency, and in turn the underlying economy, to the verge of collapse.

It does this through a series of large trades distributed over several days.

Other traders sense economic doom on the horizon as they witness these trades and decide that they too must unload positions in that currency.

The currency drops 1%, 3%, 5%, ...

The businesses in this country are forced to contend with decreased buying power as a result of the declining currency.  

The goods and services, they are buying from their trading counterparts overseas (e.g. U.S.) became a lot more expensive thanks to the currency speculators.

The currency drop continues and soon everyone is panicking.

Before long, major corporations and individuals must cut spending as foreign-produced items are more expensive than before.

This can prove disruptive and in extreme cases disastrous.

Such examples are far from regular occurrences.

Government imposed exchange limits will prevent complete currency collapse caused by speculation.

The above illustrates what could happen when currency speculation takes on a life of its own in a floating system.

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