Hard and Soft Currencies

Introduction

The global financing industry is enormous. Warren Hill in his book, Competing in the Global Marketplace suggests that "international financing extended by banks around the world reporting to the Bank for International Settlements is estimated at $6.4 trillion, including $4.6 trillion net international lending. Total world banking assets are put at more than $20 trillion, insurance premiums at $2 trillion, stock market capitalization at over $10 trillion, and market value of listed bonds at about $10 trillion. In addition, practically every international trade in goods or services requires credit, capital, foreign exchange, and insurance" (Hill, page 198). With such vast amounts of money floating in and out of global markets [as in this example], intermingled among numerous currencies, participating governments must have some way of protecting their investments and/or transactions. This paper seeks to discuss through examples, the impact of the use of hard and soft currencies in aiding in the protection of those investments and/or transactions.

Hard Currency

According to Investopedia, "hard currency" is defined as "a currency, usually from a highly industrialized country, that is widely accepted around the world as a form of payment for goods and services. Hard currency [by its nature] is expected to remain relatively stable through a short period of time and to be highly liquid in the foreign exchange market. Yet another criterion for hard currencies is that the currency comes from a politically and economically stable country such as the U.S. Europe, England, Australia, and/or Japan" (Investopedia). As hard currencies, the US dollar, European Euro, English pound and Japanese yen are all traditionally backed by hard money policy, e.g., gold, silver, bullion or platinum to support or stabilize the value of its currency with a hard, tangible, and lasting material that retains its value over a longer period. The primary strengths of hard currency are that hard currencies are freely convertible; they do not depreciate [in face value]; they are typically in strong demand and their exchange rate tends to appreciate because of steady high demand relative to supply , which is opposite of "soft currencies".

Soft Currency

Soft Currency is defined as, "weak currency who's value fluctuates often" (Investopedia). Most developed countries do not want to hold on to soft currencies due to political and economic uncertainty in the country with soft currency. Soft currency is a less desirable means of payment when compared to hard, [reliable] currency. Countries with soft currency tend to have frequent currency devaluation, balance of payment difficulties and political strife. Soft currency is typically not acceptable in exchange for currency of other countries due to its unrealistic exchange rates. Some of the current soft currencies are the peso (Mexico), the Philippine peso, the Hong Kong dollar.

How are hard and soft currencies used in global financing?

In the global financing arena, hard currency can be used to offset liquidity or "the condition in which the supply of hard currency or other assets is insufficient to meet the demands of world trade" (IMF). Take, for example the case involving the Foreign Exchange Fund in Tehran in August 2005. In August of 2005 "when oil revenues were at an all-time high, a senior Management and Planning Organization (MPO) official in Tehran, Iran indicated that "the Central Bank of Iran (CBI) was unable to convert more than $22 billion US dollars into the national currency, adding that liquidity and inflation rates would worsen if the bank injected more hard currency into its foreign exchange fund" (Iran Daily). All indications were that continued CBI withdrawals from the fund "were to blame for Iran's high liquidity growth" (Iran Daily). The article went on to suggest that "if the fund's hard currency reserves were spent on private sector projects rather than the government's current expenses, the CBI would have little impact on liquidity" (Iran Daily). In this example, one can readily see how liquidity is tied to the use of hard currency in the global market. In the example provided, Iran has pegged its currency to the stable [hard currency] US dollar through its Foreign Exchange Fund. However, the Iranian Central Bank insisted on ciphering off hard currency to fund local projects. Continued reduction of Iran's hard currency level after pegging it currency to the US dollar could certainly impact liquidity.

Soft currency use is a different animal all together. As indicated above, soft currency refers to a weak currency who's value constantly