Exam 9: The International Monetary and Financial Environment

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A convertible currency can be easily exchanged for other currencies. The most easily convertible are called hard currencies, and include the British pound, European euro, Japanese yen, and U.S. dollar. They are strong, stable currencies that are universally accepted and used most often for international transactions. Nations prefer to hold hard currencies as reserves because of their relative strength and stability in comparison to other currencies.
A currency is nonconvertible when it is not acceptable for international transactions. Some governments may not allow their currency to be converted into a foreign currency.
The governments of some countries impose restrictions on currency convertibility in order to preserve their supply of hard currencies, such as the euro or the U.S. dollar, or to avoid the problem of capital flight. Capital flight is the rapid sell-off by residents or foreigners of their holdings in a nation's currency or other assets. This usually occurs in response to a domestic crisis that causes them to lose confidence in the country's economy. The investors exchange their holdings in the weakening currency for those of another, often a hard currency. Capital flight from a country diminishes its ability to service debt and pay for imports.