Banking System and Macroeconomic Effects †MyAssignmenthelp

Question: Discuss about the Banking System and Macroeconomic Effects. Answer: Introduction: Crypto currencies are forms of digital currency. These currencies use encryption techniques in order to regulate the generation of currency units. Bitcoin is one such crypto currency. Crypto currency is not yet considered as a legal tender in most countries. In fact, at present most of the central banks of the world are putting efforts to ban the trade of crypto currencies. Over the last few years, certain crypto currencies like Bitcoin have garnered immense attention from across different traders owing to their volatile nature. Bitcoin was introduced in the year 2009. The currency is traded without a middleman and with zero bank involvement. It is a peer to peer network through which this currency is traded and transactions are made directly to the parties. Bit coin can be used to trade in goods and services, some use it as a form of investment and some are using it for making payment of businesses (Popper, N., 2015). However, most countries have yet not accepted it as a legal payme nt methodology. It is similar to digital cash transaction as Bitcoin can also be sent through mobile applications and computers. Bitcoin is stored in a digital wallet. These wallets are used as a virtual bank account that allows users to save, send and receive their payments. These wallets are not recognised by the FDIC as methods of paying for goods or services. Bitcoin works as a medium of exchange for goods and services in four countries at the moment which are Japan, Canada, Germany and Holland. Bitcoin is considered to be a form of currency as it can be stored for future investments (Forrester and Solomon, 2013). Bitcoin investment of an individual can also reflect upon the purchasing power of consumer. Consumer have the option to buy the currency, hold it in their accounts or book profits as they deem profitable depending upon the volatility in the market (Bit coin, 2018). Merchants who accept Bit coin as a payment can convert it into standard currency that is in Dollars, Euros etc. Bitcoin has some advantages as it introduces a new payment mechanism; tipping system, automated payment solution, time locked payment management, public asset tracking, low trust escrow services, micro payment channels and more such facilities (Bit coin, 2018). Another advantage of Bitcoin is that its high volatility in the currency market makes it a high risk and high return asset. Exposure to Bitcoin currency leads to various scams and frauds in the economy. It does not have any standardised value for refunds. Bitcoin does not have a fixed value and the high volatility of the currency only makes it more susceptible to fluctuations. This breeds corruption and leads to frauds within economies. Values of Bit coin fluctuate very frequently making it difficult for people to use it as a medium of exchange. If a particular product is bought or sold in return for Bitcoin then it is impossible to get a fair deal to complete the transaction in the future. According to the central bank reviews, laundering of money is done secretly from the country using Bitcoin. Since Bitcoin is not considered to be a safe asset to deal in, various governments are not allowing investment in these types of crypto currencies. Bitcoin is extremely difficult to convert into a physical form of currency. At present conversion of Bitcoin to other currency does not happen in real time. Moreover, unlike other currencies, Bitcoin does not give its owners the convenience of withdrawing equivalent money from debit/credit cards or cheques. The use of Bitcoin has been banned by the government authorities in many countries and trade of the same is considered to be an illegal activity in nature. There is no defined regulatory body for operating the workings of these privately provided digital currencies so there is no supervision over the activities performed in these currencies. Investors have analysed a high risk involved with trading or dealing in Bitcoin making it a high risk investment. There is no particular market for these kinds of currencies. This lack of organised market for crypto currencies make them less trustworthy as compared to other assets. Crypto currency is operating in an informal way and this makes it difficult for investors to consider it a safe haven. The chances of fraud are much higher as there is no way to track this currency. Every individual can trade the currency using a public username. Extreme high volatility of the Bitcoin makes it impossible to use as a medium of exchange since it will never be possible to determine to the true value of exchange. Pegging any currency against the dollar refers to the act of fixing the currency value with respect to the value of Dollar. In other words we can say that the value of US dollar against the other currency is fixed and will not move irrespective of how the market functions. The process of pegging currency with US dollar is often conducted in oil extracting countries as US is the largest importer of oil. GCC economies are the third largest economy. The growth of this economy is highly dependent on selling oil (The Economist, 2018). By pegging the GCC against Dollar has several advantages and disadvantages. Elimination of currency fluctuations: Pegging of currency eliminates the risk of currency fluctuations and the risks associated with it. This provides stability to the currency in the international currency market. Pegging encourages the regional currency valuation as the dollar is considered to be the standard currency and by pegging with dollar, currency of other country does not fluctuate (Brooking, 2018). In countries like Saudi Arabia and Venezuela pegging with US dollar has been done in order to protect the countries from the risk of currency fluctuations because US is the major importer for oil. Various countries opt for pegging in order to increase external trade in the country. As external trade increases, the GDP of the country also increases. When pegging of a currency is done to a higher value currency then the value of the country enhances in the public opinion making it an attractive destination to invest. Therefore investment becomes easier in that country. This process also protect country from speculation Pegging also gives freedom to set rules and economic policies, interest rates and help to control inflation in the country. Therefore countries must peg their currencies to dollar in order to limit their risks. If a country currency is pegged with the US dollar then the country can take more loan as it will have a more stable environment and economy. Pegging also helps in getting better deals for international loans and interest rates provided the economys inflation is in control. The loan taken in the dollar value is harder to pay off because dollar has the high value as compared to the other currency. Therefore in the longer run, pegging would result in rising cost of capital and increased import prices (Espinoza and Prasad, 2010). Maintenance of USD reserves: The country which pegs its currency with the USD has to maintain a high reserve of dollars. It means central bank of that country has to hold a high amount of reserves in US dollars (Financial Times, 2018). Holding of foreign currency reserve (dollar) indulges a cost which adversely affects the economy. Pegging also leads to an increase in inflation. Growth and development of a country is dependent on the performance of dollar. Monetary policies are restricted in every country and are wholly dependent on the performance of the currency to which the currency is pegged. Similarly in the case of US dollar and countries pegged with it, it means that if the value of US dollar falls the currency of other country will also fall and vice versa. GCC countries whose currencies are pegged with dollar are now being forced to increase their interest rates mirroring the US interest rate increase. This is because once the currency is pegged to the dollar, monetary policies are decided by the action of Fed rather than the economys own needs. High interest rate means cost of borrowings on (debt, loans and so on) government, businesses and consumers will become more costly or expensive (The National, 2018). Tighter monetary policy will lead to low investment and saving in the economy. This is the reason countries do not prefer to peg their currency to dollar. This will ultimately hamper the macro and micro factors of economy. Nowadays countries prefer the flexible exchange rates rather than peg a currency with US dollar to know the real economic deviations in the countrys oil prices and other things (Tanha, and Dempsey, 2017). Pegging of currency damages the economy, trade, and lowers real income groups within the country in the longer run. Moreover, structural changes occur in the economy are not directly reflected through the pegging of currency. References: Bitcoin, 2018. Bit coin for developers. [Online]. Available at: https://Bit coin.org/en/Bit coin-for-developers [ACCESSED ON 30th march 2018] Bitcoin, 2018. Bit coin for individual. [Online]. Available at: https://Bit coin.org/en/Bit coin-for-individuals. [ACCESSED ON 30th march 2018] Brooking, (2018). Sustaining the GCC currency pegs: The need for collaboration. [Online]. Available at: https://www.brookings.edu/research/sustaining-the-gcc-currency-pegs-the-need-for-collaboration/. [ACCESSED ON 31th march 2018] Espinoza, R.A. and Prasad, A., 2010.Nonperforming loans in the GCC banking system and their macroeconomic effects (No. 10-224). International Monetary Fund. Financial Times, 2018. Gulfs dollar peg makes sense. [Online]. Available at: https://www.eiu.com/industry/article/1725886356/will-the-gulf-co-operation-council-currency-pegs-survive/2017-09-13. [ACCESSED ON 31th march 2018] Forrester, D. and Solomon, M., 2013.Bitcoin explained: Today's complete guide to tomorrow's currency. CreateSpace Independent publishing platform. Popper, N., 2015.Digital gold: Bitcoin and the inside story of the misfits and millionaires trying to reinvent money(pp. 156-197). New York: Harper. Tanha, H. and Dempsey, M., 2017. Derivatives usage in emerging markets following the GFC: Evidence from the GCC countries.Emerging Markets Finance and Trade,53(1), pp.170-179. The Economist, 2018. Financial Services. [Online]. Available at: https://www.eiu.com/industry/article/1725886356/will-the-gulf-co-operation-council-currency-pegs-survive/2017-09-13. [ACCESSED ON 30th march 2018]. The National, 2018. Why GCC states should ditch the dollar peg and switch to a currency basket. [Online]. Available at: https://www.thenational.ae/business/economy/why-gcc-states-should-ditch-the-dollar-peg-and-switch-to-a-currency-basket-1.700668. [ACCESSED ON 31th march 2018]