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What is a Currency Collapse?

During a currency collapse, the value of a nation's money drops significantly.
Out of control inflation could cause a currency to collapse.
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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 04 October 2014
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A currency collapse is a situation in which the value of a nation's currency drops radically in a very short period of time. As the value collapses, it can contribute to a wider economic crisis, and it can have long-lasting repercussions. Currency collapses have been implicated in a number of financial crises including the spectacular freefall of the Icelandic economy in 2008 and the Asian Financial Crisis in the 1990s.

At any given time, many different types of currency are being used around the world. Domestically, people tend to use a specific currency which is backed and printed by the government, and nations may also trade internationally in currency or currency futures. For example, a British investor might decide that the value of the Japanese yen is going to rise, and decide to invest in the yen for the purpose of selling it at a later date. Nations also use their currency for legal tender; the South African government, for example, may pay for goods and services in the rand, its own currency, or it may opt to use another form of currency as payment.

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A wide variety of things can bring about a currency collapse. One cause is a speculative attack, in which people perceive a drop in value in the future, so they opt to sell their currency to avoid taking a loss. As they sell the currency, the value begins to decline, especially if the government has a fixed exchange rate, which will force it to buy up the excess currency to keep the exchange rate stable. As the value of the currency declines, people begin to panic, selling off more and more of their reserves and causing the value to fall even further.

Speculative attacks are often spurred by disclosures of large amounts of government debt. The attack can be crippling to a national government, because it will be unable to pay off its debt, since its currency has devalued so radically. In some cases, international agencies like the World Bank may step in to provide assistance and advice to prevent a nation's currency value from dropping below a certain level.

Runaway inflation can also sometimes lead to a currency collapse, as can certain moves by governments such as radically altering interest rates. Oddly enough, these moves are often undertaken to prevent a currency collapse or financial problem, but sometimes the results of government intervention can be unpredictable.

Once a currency collapse has occurred, it can be difficult for a nation to recover. The residents of the country find that their savings have devalued overnight, leaving them with nothing, and the cost of goods can rise dramatically as a nation is forced to pay much more for imported products. Because of the devaluation, other nations will be reluctant to invest in the nation or its currency, creating a double bind in which the nation needs economic movement to escape the currency crisis, but it cannot achieve such movement without a stable currency.

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