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Speculative attack

Speculative attack

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A speculative attack is a term used by economists to denote a precipitous acquisition of something (currency, gold, emission permits, remaining quotas) by previously inactive speculators. The first model of a speculative attack was contained in a 1975 discussion paper on the gold market by Stephen Salant and Dale Henderson at the Federal Reserve Board. Paul Krugman, who visited the Board as a graduate student intern, soon adapted their mechanism to explain speculative attacks in the foreign exchange market
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...

. There are now many hundreds of journal articles on financial speculative attacks, which are typically grouped into three categories: first, second, and third generation models. Salant has continued to explore real speculative attacks in a series of six articles.

A speculative attack in the foreign exchange market is the massive selling of a country's currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...

 assets by both domestic and foreign investors. Countries that utilize a fixed exchange rate
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...

 are more susceptible to a speculative
Speculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...

 attack than countries utilizing a floating exchange rate
Floating exchange rate
A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency....

. This is because of the large amount of reserves necessary to hold the fixed exchange rate in place at that fixed level. Nevertheless, if a government chooses to maintain a fixed exchange rate during a speculative attack, they risk the chance of severe economic depression or financial collapse, as illustrated by the Argentine
Argentine economic crisis (1999-2002)
The Argentine economic crisis was a financial situation, tied to poilitical unrest, that affected Argentina's economy during the late 1990s and early 2000s...

 and East Asian financial crises.

A speculative attack has much in common with cornering the market
Cornering the market
In finance, to corner the market is to get sufficient control of a particular stock, commodity, or other asset to allow the price to be manipulated. Another definition: "To have the greatest market share in a particular industry without having a monopoly...

, as it involves building up a large directional position in the hope of exiting at a better price. As such, it runs the same risk: a speculative attack relies entirely on the market reacting to the attack by continuing the move that has been engineered, in order for profits to be made by the attackers. In a market that is not susceptible, the reaction of the market may, instead, be to take advantage of the change in price by taking opposing positions and reversing the engineered move. This may be assisted by aggressive intervention by a central bank, either directly through very large currency transactions or through raising interest rates, or by activity by another central bank with an interest in preserving the current exchange rate. As in cornering the market, this leaves the attackers vulnerable.

See also

  • Black Wednesday
    Black Wednesday
    In politics and economics, Black Wednesday refers to the events of 16 September 1992 when the British Conservative government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism after they were unable to keep it above its agreed lower limit...

    , in which a speculative attack on the pound sterling
    Pound sterling
    The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...

     resulted in a forced withdrawal from the Exchange Rate Mechanism, a system of fixed exchange rates in the EU.
  • Currency transaction tax
    Currency transaction tax
    A currency transaction tax is a tax placed on a specific type of currency transaction for a specific purpose. This term has been most commonly associated with the financial sector, as opposed to consumption taxes paid by consumers....

  • Currency crisis
    Currency crisis
    A currency crisis, which is also called a balance-of-payments crisis, is a sudden devaluation of a currency caused by chronic balance-of-payments deficits which usually ends in a speculative attack in the foreign exchange market. It occurs when the value of a currency changes quickly, undermining...

  • Financial transaction tax
    Financial transaction tax
    A financial transaction tax is a tax placed on a specific type of financial transaction for a specific purpose.This term has been most commonly associated with the financial sector, as opposed to consumption taxes paid by consumers. However, it is not a taxing of the financial institutions themselves...

  • Spahn tax
    Spahn tax
    A Spahn tax is a type of currency transaction tax that is meant to be used for the purpose of controlling exchange-rate volatility. This idea was proposed by Paul Bernd Spahn in 1995.-Early history:...

  • Speculation
    Speculation
    In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...

  • Tobin tax
    Tobin tax
    A Tobin tax, suggested by Nobel Laureate economist James Tobin, was originally defined as a tax on all spot conversions of one currency into another...