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  • Card 5 / 9:
    This chapter has explained that “one of the most economically destructive effects of exchange rate fluctuations can happen through the banking system,” if banks borrow from abroad to lend domestically. Why is this less likely to be a problem for the U.S. banking system?

    The problem occurs when banks borrow foreign currency but lend in domestic currency. Since banks’ assets (loans they made) are in domestic currency, while their debts (money they borrowed) are in foreign currency, when the domestic currency declines, their debts grow larger. If the domestic currency falls substantially in value, as happened during the Asian financial crisis, then the banking system could fail. This problem is unlikely to occur for U.S. banks because, even when they borrow from abroad, they tend to borrow dollars. Remember, there are trillions of dollars in circulation in the global economy. Since both assets and debts are in dollars, a change in the value of the dollar does not cause banking system failure the way it can when banks borrow in foreign currency.

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Source:  OpenStax, Principles of macroeconomics. OpenStax CNX. Jan 09, 2015 Download for free at http://legacy.cnx.org/content/col11750/1.2
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