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What is a Currency Crisis? - Definition & Examples

Instructor: Artem Cheprasov
This lesson defines currency crisis. You'll also learn about some of the many causes of currency crises and some recent examples of them from around the world.

A Crisis With Your Currency

Have you ever had a crisis with some of your currency? Maybe you didn't have enough cash on you one day. Perhaps someone stole your money. That was a small-scale, albeit unfortunate, personal currency crisis in a manner of speaking.

Of course, actual currency crises can occur on a national scale and they can be pretty bad. In this lesson, you're going to learn what these are and some examples of them from recent memory.

What is a Currency Crisis?

A currency crisis is a term used to refer to a type of financial crisis that encompasses an acute devaluation of a currency. That is to say there is a sudden and often severe drop in the value of a currency.

For example, let's say that you have 1 U.S. dollar. We'll pretend that for 1 U.S. dollar you can get 30 Russian rubles. We'll also say that this exchange rate has been pretty stable for the last 15 years or so.

Then, one day, you see that the value of the ruble falls dramatically. By falling, we mean the number of rubles you can get for 1 U.S. dollar is now a lot more than it is before. Instead of 30 rubles for 1 dollar, it may be something like 90 rubles for 1 dollar. The purchasing power of the Russian ruble has gone down dramatically and thus the currency has been partially (albeit significantly) devalued. This is a currency crisis.

It's a financial crisis in the broader scheme of things because it affects the entire economy. Pretend that you are a Russian citizen working in Russia. You are getting paid in rubles. Let's say your salary is 300,000 rubles a month. By the old currency conversion rate, this means your purchasing power was equivalent to 10,000 U.S. dollars a month. With the currency crisis, your purchasing power of 300,000 rubles a month drops by 2/3. This means your salary is now equivalent to roughly $3,333/mo.

Why is this a problem? Well, there are numerous major reasons for this, which are beyond this lesson's scope but we can sum things up with one very clear example. Your Russian employer isn't going to raise your salary to compensate for the entirety (if any part) of the currency's devaluation. This means you are getting paid essentially three times less for the same amount of work. That's kind of unfair, right?

It also means that when you go abroad, you'll be able to purchase much less because everything will be three times more expensive than it was before for you, even though the price of the item (in USD) hasn't changed at all.

When currency crises occur, there is often a lot of speculation that occurs in the forex, or foreign exchange markets. These are markets where people can buy and sell currencies much like you can buy and sell stocks on the U.S. stock market. This can devalue the currency even more. It's like a devaluation bubble. People panic, sell off the currency to prices way beyond reasonable expectation given current circumstances, and the currency devalues even more than it should.

Causes

The causes of currency crises can be many. It's often difficult to see one coming albeit in retrospect many reasons seem to arise. Some of these causes include any combination of the following:

  • Pure speculation. That is to say, there is nothing wrong with the currency at the heart of things but investors and traders may think so and devalue the currency with their own actions.
  • Central bank policies that may slow the economy.
  • A significant event, such as an assassination of a country's leader, which rattles the markets
  • Wars
  • Sanctions placed upon a nation by another
  • An over-reliance on foreign investment/foreign debt
  • An over-reliance on one source of income for the economy
  • Market panics based on any of the above

Examples

There are numerous examples of currency crises in recent history. For example, there was the Latin American currency crisis of 1994. Here, a combination of factors, such as poor economic reforms, an assassination of a presidential candidate, and poor central bank decision led to the devaluation of the Mexican peso. The mistake the Mexican government made was that it didn't let the currency devalue a large enough amount to match its economic problems and this caused panicked investors to push the Mexican peso lower and lower.

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