Currency Crisis in Britain - Essay Example

? CURRENCY CRISIS Part One The recent appointment of Mark Carney as the next Bank of England Governor for the subsequent five years has elicited several response. This is ascribed to the fact that several people had anticipated that Paul Tucker, the deputy governor was the one going to succeed Sir Mervyn King, the outgoing governor. On the other hand, some economists argue that Britain’s Chancellor, George Osborne gambled by naming Mark Carney as the next person to be at the helm of Bank of England from 1st July 2013. They believe that the modern central banker is not experienced in the field that he is expected to lead. However, his academic excellence and outstanding performance in various portfolios he has held proves his critics wrong (Blackden 2012). The responsibility of salvaging the United Kingdom’s currency crisis will be his primary responsibility as the governor of the Central Bank of England. Blackden’s article in The Telegraph highlights some of the attributes that Mark Carney possess that makes him a good choice for the position. The article clearly outlines possible ways that economists think Mark Carney would use to restore Britain’s dwindling economy. In this way, it has proved and highlighted some of the theories proposed earlier by economists in their attempts to explain the causes and ways of minimizing currency crisis. Mark Carney has been portrayed to believe in closer supervision and maintenance of high capital requirements for large financial institutions (Blackden 2012). This is opposed to what Sir Mervyn King advocates. However, it is worth noting that underdevelopment of the banking sector can cause a currency crisis. This is because the central bank may focus on financing the banking sector to bail them from their financial problems at the expense of maintaining the peg (Komulainen 1999). This may bring currency instability leading to a currency crisis. Studies have revealed that lack of proper supervision of financial institutions in Asia led to a currency crisis that affected Thailand and Malaysia (Kaminsky & Reinhart 1999). Blackden also asserts that financial analysts expect Mark Carney to make British banks hold far much capital than they are required to by the Basel III regulations. This is aimed at making the financial system safe as the economy recovery process is being conducted. It is similar to the canonical currency-crisis model. This model as proposed by Stephen Salant asserts that speculators have tendencies of holding exhaustible resources with expectations that their prices would rise. The increase in the prices of these resources will then offer the speculators a return rate equivalent to other assets (Krugman n.d.). In this way, the exchange rates would be stabilized. Therefore, it is necessary to comprehend Blackden’s assertion on the need for Mark Carney to empower British banks to hold massive capital. New-wave theories have also explained that recent currency crises affecting various countries are as a result of the weak banking systems. Therefore, holding massive capital would imply that the banks can sustain themselves and would not need bailing from the central bank (Fourcans & Franck 2003). In this scenario, the central bank will prevent a possible currency crisis. The article also mention that Mark Carney would urge United Kingdom’s leading companies to invest in new markets such as Brazil, China and India. Opening up and venturing into new markets would help Britain a great deal since it would steer the economy to a fast-paced recovery process (Fourcans & Franck 2003). On the other hand, venturing into foreign and emerging markets would give investors the confidence that the currency is stable; thus, they would not withdraw from the British market due to fear of imminent collapse of the economy (Fane 2000). Additionally, Mark Carney’s appointment is expected to save UK from the imminent effects of the on-going Euro zone crisis. This is because the United Kingdom depends on foreign money to fund most of its pertinent trade deficit. Therefore, if the Euro zone crisis goes on, and spills over to the United Kingdom, then the UK would suffer a currency crisis. This would come about as a result of the foreign investors leaving the pound; making its value collapse; and in the long run, the government’s cost of borrowing rising sharply (Agencies-guardian.co.uk 2012). If the Euro zone crisis extends to the worst, the Treasury may command the Bank of England to fund its borrowing needs by printing money. This would make the United Kingdom face the risk of inflation, and not its inability to pay debts. As Mark Carney wait to begin his tenure as the governor of Bank of England, the bank’s MPC (Monetary Policy Committee) has maintained a record low interest rate of 0.5% (Agencies-guardian.co.uk 2012). This is attributed to the fact that the United Kingdom’s economy grew by 1% between the months of July and September 2012; something that was not expected. Maintaining the interest rates imply that the bank will not resort to printing money as a policy tool. This is because pumping additional money into the economy would lead to inflation; thus, affecting the economy further. It is worth noting that Blackden’s article has highlighted some of the theories learnt in this unit. This is demonstrated in the manner it has brought to light various ways in which Mark Carney, as the next governor of the Bank of England would rescue the ailing British economy and prevent a likely currency crisis. Additionally, it puts the theories learnt in this unit to question since it opens our eyes to enable us see how they relate to real life situations. Part Two Blackden’s article is worth analyzing, since it has successfully explicated some of the issues related to currency crises. In as much as the writer was focused on explaining whether the new Bank of England’s governor is fit for the position, he has also elaborated some of the aspects that must be addressed in order to save the country from a currency crisis. The writer also aims at portraying Mark Carney as an individual who is better placed to prevent a repeat of what happened in 1992 causing Britain to exit the European Monetary System’s exchange rate mechanism (Tirole 2002). His ability to manage a currency crisis will be pegged on his key decisions as a governor to control credit and money creation. This is because expansions of money base and domestic credit are closely linked to inflation, capital outflow, and depreciation of expectations. This leads to speculative attacks that may wipe out the reserves leading to a currency crisis (Komulainen 1999). It is evident that managing an economy as large as Britain’s is a difficult role since it does not only involve regulating inflation, but also managing London. This is reinforced by Bill White, former Bank of International Settlement’s chief economist’s assertion, which says that the governor’s role is tasking and extremely different from administering a central bank in Canada. From this, one can conclude that managing and preventing a currency crisis demands a lot (Pesenti & Tille 2000). In as much as Mark Carney had helped Canada to recover from their economic crisis; Bill White still thinks that the task ahead of him is still challenging. The belief that currency crises would not end soon; and that they would not be solved by several summit meetings is a strong statement echoed in the article. This is because it questions the role played by the governments of the affected countries. It also reiterates the fact that too much talk without any action being conducted cannot solve the currency crises faced by several economies (Isard 2005). Therefore, governments of such countries are advised to ensure that they keep their rates relatively low for some time in order to stimulate demand and investment (Komulainen 1999). This will work in the sense that many investors would see the stability of the currency and invest countries maintaining low rates. The investors would do so since they would be anticipating an increase in the rates, and this implies that their return on investment would be high after sometime (Eichengreen et al. 1995). Additionally, the more the investors bring in their resources in an economy, the further it moves from currency crises and economic slump. In as much as the article talks about dialogue and communication to prevent currency crises; it does not outline the process and models that should be followed to ensure that the currency crises are solved once and for all. However, in the recent decades, the international economic integration has improved significantly. This can be attributed to economic globalization (Blackden 2012). Migration, expansion of international trade, as well as spread of useful economic knowledge and technological advancements are ways that can be used to seek ways of solving financial crises (Isard 2005). Additionally, Britain should focus on having government policies that provide stimulus to innovations in transportation technologies and communication, as well as influencing the existing technologies to encourage cross-border flows of money, goods, people, and ideas. In this way, the efforts that would be made by the incoming governor would yield fruits. This is ascribed to the fact there would be proper laid down policies to follow the economy’s restoration process (Fane 2000). Blackden’s article focuses on whether Mark Carney is the best candidate to fit into Sir Mervyn King’s shoes as the next Bank of England Governor, as well as how he would help salvage Britain from its economic slump. However, it fails to outline the causes of Britain’s currency crisis. It is a fact that one should identify the cause of a problem before trying to solve it. In this way, one would know the kind of problem he or she is handling so that he or she can choose the best strategy that addresses the needs of the problem (Kaminsky & Reinhart 1999). Therefore, the failure of the writer to mention the cause and the extent of Britain’s economic slump makes it difficult to concur with the options that he has suggested that Mark Carney would use to solve the crisis. For instance, feasibility studies conducted in Asia after its 1997-98 currency crises revealed that whimsical shifts in the market expectations, weak policies and structural imbalances were the main causes (Pesenti & Tille 2000). From this study, it was extremely easy to conduct the recovery process since the parties involved in the currency recovery knew which area of the economy to handle. In the article, New York and London have been mentioned as the biggest financial centers in the world. However, the writer has failed to mention how a currency crisis in either of them would affect the performance of these cities. It has been proved that economies that depend on each other are affected in case one of them is facing a crisis (Fourcans & Franck 2003). This financial crisis facet is known as contagion. The best example of a contagion scenario is the Thailand and Malaysia financial crises (Krugman 1979). In as much as Malaysia is a different country from Thailand, they deal in the same products in the world market. Therefore, devaluation in the Thailand currency automatically depressed the Malaysian exports, triggering the currency crisis (Allen et al. 2005). Studies also reveal that high capital mobility has transformed the economic environment since it is the promoter of contagion effect of currency crises. This is demonstrated in the manner in which investors seek weak points from emerging markets when one part of the world is facing currency crises (Komulainen 1999). Therefore, it is evident that Blackden’s article does not clearly explain the connectedness between two economies, London and New York, and how currency crisis in one economy can spill to the other. In conclusion, Blackden’s article is a must read for any person who wishes to have a better understanding of Mark Carney as the next Bank of England Governor. Additionally, those who would like to comprehend the manner in which the next governor would conduct his business in the Britain economy to prevent any currency crisis should read the article. This is because it has demonstrated several models attributed to currency crises. References Agencies-guardian.co.uk, 2012. European Central Bank and Bank of England hold interest rates. The Guardian. Available at: http://www.guardian.co.uk/business/2012/nov/08/bank-holds-interest-rates [Accessed December 10, 2012]. Allen, F., Chui, M. & Gai, P., 2005. Private Sector Involvement and International Financial Crises, NewYork: Oxford University Press. Blackden, R., 2012. Can Mark Carney save Britain’s economy? The Telegraph. Available at: http://www.telegraph.co.uk/finance/economics/9716175/Can-Mark-Carney-save-Britains-economy.html. Eichengreen, B., Rose, A.K. & Wyplosz, C., 1995. Exchange Market Mayhem: The Antecedents and Aftermath of Speculative Attacks. Economic Policy, 21, pp.249–312. Fane, G., 2000. Capital Mobility, Exchange Rates and Economic Crises, Cheltenham, UK: Edward Elgar Publishing. Fourcans, A. & Franck, R., 2003. Perspective Currency Crises: A Theoretical and Empirical Perspective, Cheltenham, UK: Edward Elgar Publishing. Isard, P., 2005. Globalization and the International Financial System, Cambridge, England: Cambridge University Press. Kaminsky, G.L. & Reinhart, C.M., 1999. The Twin Crises: The Causes of Banking and Balance of Payments Problems. American Economic Review, 89, pp.473–500. Komulainen, T., 1999. Currency Crisis Theories – Some Explanations for the Russian Case. BOFIT Discussion Papers, 1. Krugman, P., 1979. A model of balance of payments crises. Journal of Money, Credit and Banking, 11, pp.310–325. Krugman, P., Currency Crises. Available at: http://web.mit.edu/krugman/www/crises.html. Pesenti, P. & Tille, C., 2000. The economics of currency crises and contagion: An introduction. Federal Reserve Bank of New York Economic Policy Review, 6(3), pp.3–16. Tirole, J., 2002. Financial Crises, Liquidity, and the International Monetary System, Princeton, New Jersey: Princeton University Press. Read More