The Credit Crunch and Global Currency

Posted by Allison on 1 April 2009, 16:17

Hard Times

The credit crunch has slowly been tightening its grip over the past year, and it is now reaching crisis point. With banks collapsing across America and Europe on a weekly basis, and governments stepping in to bail them out, we may not yet have witnessed the full devastating effect of a global recession that has long been threatening to make itself felt.

Over recent weeks, the global financial crisis has been dominating the headlines like never before. The US government's proposed $700 billion Wall Street bailout has caused shockwaves throughout the financial world, and all fingers are crossed that it will be able to prevent us from falling further into very dark times indeed.

Credit Crunch

In such times, the collapse of another bank seems commonplace, and it seems that no institutions are safe. But the credit crunch has not only affected major companies and banks that are collapsing under the weight of their own bad debts. The rapid demise of such colossal institutions creates ripples right around the world, and global currencies have all been affected in one way or another.

It is not easy to predict the patterns in which currencies are altered by the ongoing credit crunch, and for this reason changing currency rates do not make the headlines in the same ways as $700 billion bailouts. But one thing is certain: currencies cannot remain unaffected by the global credit crunch, and the fluctuations that have been witnessed will continue to occur as the weeks and months go on, meaning you will have to keep your currency converter to hand at all times.

There are many factors at work that determine the changing values of global currencies. These depend on how large the currency is, how safe it is considered, and how the economy of the country that uses it is faring. Patterns and predictions are made, but no one really knows how different global currencies will be affected over time. Here is a general overview of how some of the major global currencies have dealt with the credit crunch so far.

The Dollar

The mighty dollar, or the 'greenback', was once the unquestionable world currency, and in all reality this has not yet changed. But in recent times it has certainly taken a battering.

For Americans holidaying across the Atlantic at the beginning of the decade, the exchange rates were far more favorable for the dollar against the pound, with averages of $1 to £0.77 common. But as the decade has gone on, it has shrunk to as little as £0.5 at times, and Americans have had to witness their hard earned money halve in value as soon as they step foot off the plane.

This was in part due to the pound's unstoppable surge in strength that saw huge numbers of Brits taking cheap holidays both in Europe and across the Atlantic. But the tide has once again turned, and this can in part be blamed on the credit crunch.

When the credit crunch phenomenon first made the news last year, the dollar made a sudden surge after five years of falling in value. According to the International Herald Tribune, banks and fund managers suddenly paid back all their loans at once that had been used to buy risky mortgage securities, which led to a rally of the dollar against both the pound and the euro.

Therefore, despite widespread argument that the dollar should no longer be considered the de facto world currency, according to the Tribune “it remains the world's go-to reserve currency in times of market turmoil”.

The safety of the dollar gives it a certain security against the credit crunch, and this has been apparent indeed for people living on both sides of the Atlantic. Americans considering traveling to the UK are enjoying the sudden boom in the value that their dollars now have, with $1 now buying a lot more pounds, £0.57 at the time of writing. And as the credit crunch continues to go on, this could well go even higher.

This is all great news if you are an American going on holiday to the UK, but if you are going further a field into Europe it may not be quite so rosy. The Euro has strengthened a lot over the last year, meaning both inhabitants of the US and the UK are not getting the same deals that they used to in mainland Europe.

However, according to Market Watch, the dollar has recently enjoyed a surge in its value, and in the third quarter of the year it “recouped everything that it lost in the previous seven months and more”, marking a “simply breathtaking” recovery.

Recent surges can be put down to the proposed bailout plan for the US economy, which is currently going through the process of approval, and the result of this will have a large effect on the state in which the dollar emerges. Even the news of the proposed bailout sent the dollar gaining in strength, so if it does get approved then this should lead to a positive effect on the currency.

But the US economy is not immune to events outside of its own borders, and the international effects of the credit crunch will also affect the performance of the dollar. Ireland recently announced that it had gone into recession, and although it is the first of the EU countries to do so, Germany, the UK, and Spain are all likely to follow. What does this mean for the US? Well, the US economy has a strong exports sector, and therefore relies on strong international economies to increase its exports. As more countries slip into recession, the effects on the US economy will be huge, and this could well have lasting implications on the value of the dollar.

The Pound

The Great British pound is suffering a hangover as it finally comes down from its mantel as one of the most powerful currencies of the past decade. To the delight of many Britons, as recently as a few months ago it was possible to get US$2 for £1, which led to a surge in trips across the pond to take advantage of cheap goods and budget weekend breaks. However, over recent months things have not been so rosy, and the pound hit a new low against the dollar recently of $1.76.

On 29th September 2008, Bloomberg reported that this day saw the pound's value drop against the dollar “by the most in 16 years” after the UK government was forced to step in to seize the Bradford & Bingley bank, the second UK bank to collapse as a result of the credit crunch after Northern Rock floundered last year.

However, on the same day as the pound dropped against the dollar it also fell harshly against the Euro, although the reason for this was on the news that mortgage approvals had fallen to the lowest levels for nine years.

These two separate events provide a good example of how currencies are affected by numerous different scenarios. In this case, the Bradford & Bingley collapse, combined with the low mortgage approval levels announcement, affected the pound's worth against two different currencies. This may just seem like a particularly bad day for the pound, but what is clear is that both changes came as a result of the credit crunch.

Financial analysts in the UK have stated on many occasions that the sterling cannot perform in these difficult market conditions, and that whereas the dollar is seen as a refuge in difficult times, the pound does not enjoy the same security. Whenever a bank fails in the UK the pound takes a big hit in a way that is not seen with the dollar.

One thing that affects the value of a country's currency is the amount of growth that the economy is experiencing. The UK economy is currently threatening to go into recession, and even the mention of this can send the value of the pound crashing. This was witnessed in August when the Chancellor of the Exchequer, Alistair Darling, mentioned during an interview that growth in the economy was lower than expected. This led to a large hit on the pound, from which it will take a long time to recover.

Once again, the slow growth of the economy has been directly linked to the credit crunch. Bloomberg recently announced that “the UK economy grew at the weakest annual pace since 1992”, and that the financial crisis has “curbed investment, construction, and industrial production.” All such factors have a negative effect on the value of the pound on the global market, as has been shown recently.

The banking system bears a great deal of responsibility for the negative effect on the UK economy. As the banking system has been hit particularly hard as a direct result of the credit crunch, there is less credit available, which means less people taking out mortgages and a shrinking of the housing sector as a result. All of this affects the UK economy, and as a result the value of the pound.

Opinions on where the pound is headed vary, with some forecasts more gloomy than others. As reported recently in Bloomberg, according to Hans-Guenter Redeker, global head of currency strategy at BNP Paribas SA, in a few months the pound will go down to $1.74, and within a year will drop further to $1.65. Bad news for Brits, but good news for Americans. However, others predict that the pound will rally to $1.85, and then settle at around $1.8. Of course, these are just predictions, and no one really knows what is going to happen.

For the average Briton with limited knowledge about the value of currencies on the world market, the degrading value of the pound has been evident mainly through the rising expense of taking a holiday abroad. Cheap flights to Europe, combined with cheap hotels and transport on arrival, were until recently seen as the norm. But since the beginning of the year things have been changing.

While the pound has been falling, the euro has been storming ahead, and Britons have suddenly been left having to fork out lots more for their holidays abroad, a factor that has led many people to shun traveling beyond their own shores altogether.

Other measures have been taken against the failing economy. In the historic town of Lewis in East Sussex, the residents recently took drastic measures against the credit crunch when they came up with their own currency. On 9th September 2008, about 10,000 notes were launched in the town, making the 'Lewis Pound' the largest release of local currency since 1885.

Although the aim was to encourage more local shopping and help the environment, there is no doubt that the current economic conditions have been to the town's advantage in getting the new currency off the ground. But whether it will become a currency to rival the pound is another matter.

The Euro

The euro is the official currency of the Eurozone, which currently comprises 15 member nations including France, Germany, Italy, and Spain. As well as these 15, the euro is also used as currency in a further 11 countries, and even more countries choose to peg their own currencies against it. It is therefore the largest cash circulation in the world, and the second largest reserve currency after the dollar.

The euro is seen as more stable than many other currencies because of a number of factors. These include the large size and status of the countries that use it: a greater number of strong economies will provide a currency with a greater level of security. Its status as a reserve currency is also a strength for the euro, as this allows the member nations to purchase commodities at cheaper rates than other nations as they have less to pay in transaction costs.

Over the past year, the euro has been going from strength to strength, and is now at its highest ever rate against the pound and the dollar. However, it has fluctuated in recent times as a direct result of news coming out of the US on its economy. The US is still the powerhouse of global finance and, despite the strength of the euro, what happens in America still has a large effect on its strength.

However, the euro remains a very strong currency on the world market. It is seen as a safe haven for investors who do not want to take risks, and some analysts have even claimed that it will take over the dollar as the main world currency by as early as 2015.

But once again, such predictions are just that: predictions. In these volatile times, the only certainty is that nothing is certain.

Other Currencies

Other than the three main currencies discussed so far, most other currencies have been affected to some degree by the credit crunch, with some of them fairing better than others.

One country that has been hit particularly hard is Iceland. Although its economy has been doing incredibly well over recent years, the credit crunch has come along and caused nothing short of a disaster.

Once again, the problems have come as a result of the actions of the country's main banks. Its two major players, Landsbanki Islands HF and Kaupthing Bank, both borrowed huge amounts of money to fund lending and acquisitions, and now that cheap credit has all but disappeared, trouble has appeared on Iceland's remote shores.

This can be seen most clearly through the value of their national currency, the Icelandic krona, which fell 26% against the euro this year alone. Such devastating losses have led this proud nation to consider joining the EU, but this is not a popular choice for the general population as they have never previously considered such a move. However, desperate times call for desperate measures.

Another currency to falter in the credit crunch has been the South Korean Won. It has lost almost 19% against the dollar this year alone, which is having huge effects on the inflation rates of the country. All of this is as a direct result of financial instability caused by the credit crunch.

As reported in Trading Charts, Jeong Seung-ji, a currency analyst at Samsung Futures Inc, said that “as problems related to the US financial market persist, the local market will likely see fluctuation.” Once again, it is clear that the mighty reach of the US economy stretches right across the globe, and no currency is immune to changes as a direct, or indirect, result of the credit crunch.

Gold – The New Currency

In such uncertain times, people have been looking for safer ways to invest their money, and one such 'currency' is gold. Gold is a traditional refuge in times of crisis, and the credit crunch is no different. The Guardian reports that after the US government bailed out AIG, gold went up by $60 an ounce, which equates to a 12% rise. Some analysts are now saying that it might even go higher than the $1,000 an ounce that it reached in March.

But whether you choose to invest in gold or not, one thing is for certain: we are living in uncertain times, and currencies across the world will continue to fluctuate throughout the credit crunch. Although in general you will get less for your pound and more for your euro than you would have done a few months ago, no one is a hundred per cent sure what is going to happen. The best thing you can do is keep an eye on the markets and keep your currency converter handy.