Currency Substitution

AAA

DEFINITION of 'Currency Substitution'

The use of a foreign currency in transactions in place of the domestic currency. The foreign currency thus serves as a medium of exchange. Countries using flexible exchange rates can experience problems if there is a high rate of currency substitution because they can no longer control all currency types through monetary policy. The higher the rate of currency substitution, the greater the likelihood of monetary disturbances caused by changes in the foreign currency.

BREAKING DOWN 'Currency Substitution'

A country may choose to use flexible exchange rates rather than fixed exchange rates in order to mitigate the effect of foreign currency fluctuations on the domestic currency and economy. An increase in the rate of currency substitution means that the domestic economy can fall victim to rapid changes in exchange rates, and thus may experience monetary increased shocks from both home and abroad.

RELATED TERMS
  1. Monetary Policy

    The actions of a central bank, currency board or other regulatory ...
  2. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  3. Dollarization

    A situation where the citizens of a country officially or unofficially ...
  4. Foreign Currency Swap

    An agreement to make a currency exchange between two foreign ...
  5. Linked Exchange Rate System

    A system of managing a nation's currency and exchange rate by ...
  6. Pegging

    1. A method of stabilizing a country's currency by fixing its ...
Related Articles
  1. Forex Education

    Currency Exchange: Floating Rate Vs. Fixed Rate

    Baffled by exchange rates? Wonder why some currencies fluctuate while others are pegged? This article has the answers.
  2. Personal Finance

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  3. Forex Education

    Dual And Multiple Exchange Rates 101

    Why would a country choose to implement dual or multiple exchange rates? It's risky, but it can work.
  4. Personal Finance

    What Are Central Banks?

    They print money, they control inflation, and much, much more. All you need to know about central banks is here.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI South Africa

    Learn more about the iShares MSCI South Africa fund, which is an NYSE-listed exchange-traded fund offered and managed by BlackRock.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI EAFE Small-Cap

    Read an in-depth analysis of the iShares MSCI EAFE Small-Cap Fund, a well-managed exchange-traded fund that tracks small-cap international stocks.
  7. Mutual Funds & ETFs

    ETF Analysis: Vanguard Global ex-US Real Estate

    Take an in-depth look at the Vanguard Global ex-U.S. Real Estate ETF, an international property fund tilted toward Asian markets.
  8. Economics

    Is the Yuan a Yawn or a Nightmare for Investors?

    China’s decision to change the method of setting its currency exchange rate caused global shock waves last week.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares International Select Dividend

    Learn how the iShares International Select Dividend ETF provides investors an opportunity to gain exposure to high-quality companies outside the United States.
  10. Economics

    Signs of a Struggling Economy?

    Last week was another difficult one for stocks, marked by a bruising mid-week selloff triggered by China’s surprise devaluation of its currency. 
RELATED FAQS
  1. What are the goals of covered interest arbitrage?

    The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
  2. What kinds of costs are included in Free on Board (FOB) shipping?

    Free on board (FOB) shipping is a trade term published by the International Chamber of Commerce or ICC, that indicates which ... Read Full Answer >>
  3. What are the differences between B-shares and H-shares traded on Chinese stock exchanges?

    Equity listings in China generally fall under three primary categories: A shares, B shares and H shares. B shares represent ... Read Full Answer >>
  4. What are the differences between H-shares and A-shares on Chinese and Hong Kong stock ...

    Publicly trade companies in China generally fall under three share categories: A shares, B shares and H-shares. A-shares ... Read Full Answer >>
  5. Why are financial markets considered to be transparent?

    Financial markets are considered transparent due to the fact it is believed all relevant information is freely available ... Read Full Answer >>
  6. How does a Foreign Institutional Investor (FII) manage currency risk when investing ...

    A foreign institutional investor (FII) manages currency risks (inflation and exchange rate risk) by using traditional tools ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
  2. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions charged on the transaction, regardless of favorable market ...
  3. Tiger Cub Economies

    The four Southeast Asian economies of Indonesia, Malaysia, the Philippines and Thailand. Tiger cub economy indicates that ...
  4. Gorilla

    A company that dominates an industry without having a complete monopoly. A gorilla firm has large control of the pricing ...
  5. Elephants

    Slang for large institutions that have the funds to make high volumes trades. Due to the large volumes of stock that elephants ...
  6. Widow's Exemption

    In general terms, a widow's exemption refers to the amount that can be deducted from taxable income by a widow, thereby reducing ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!