||This article possibly contains original research. (May 2012)|
Factors contributing to a currency's hard status might include the long-term stability of its purchasing power, the associated country's political and fiscal condition and outlook, and the policy posture of the issuing central bank.
Conversely, a soft currency indicates a currency which is expected to fluctuate erratically or depreciate against other currencies. Such softness is typically the result of political or fiscal instability within the associated country.
The paper currencies of some developed countries have earned recognition as hard currencies at various times, including the United States dollar, Euro, Swiss franc, British pound sterling, Japanese yen, and to a lesser extent, the Canadian dollar and Australian dollar. As times change, a currency that is considered weak at one time may become stronger, or vice versa. However, countries that consistently run large trade surpluses tend to have hard currencies.
One barometer of hard currencies is how they are favored within the foreign-exchange reserves of countries:
The US dollar (USD) has been considered a strong currency for much of its history. Despite the Nixon Shock of 1971, and the United States' growing fiscal and trade deficits, most of the world's monetary systems have been tied to the US dollar due to the Bretton Woods System and dollarization. Countries have thus been compelled to purchase dollars for their foreign exchange reserves, denominate their commodities in dollars for foreign trade, or even use dollars domestically, thus buoying the currency's value.
The Swiss franc (CHF) has long been considered a hard currency, and in fact was the last paper currency in the world to terminate its convertibility to gold. In the summer of 2011, the European sovereign debt crisis lead to rapid flows out of the euro and into the franc by those seeking hard currency, causing the latter to appreciate rapidly. On September 6, 2011, the Swiss National Bank announced that it would buy an "unlimited" number of euros to fix an exchange rate at 1.00 EUR = 1.20 CHF, to protect its trade. This action temporarily eliminated the franc's hard currency advantage over the euro but was abandoned in January 2015.
Investors as well as ordinary people generally prefer hard currencies to soft currencies at times of increased inflation (or more precisely increased inflation differentials between countries), at times of heightened political or military risk, or when they feel that one or more government-imposed exchange rates are unrealistic. There may be regulatory reasons for preferring to invest outside one's home currency, e.g. the local currency may be subject to capital controls which makes it difficult to spend it outside the host nation.
For example, during the Cold War, the ruble in the Soviet Union was not a hard currency because it could not be easily spent outside the Soviet Union and because the exchange rates were fixed at artificially high levels for persons with hard currency, such as Western tourists. (The Soviet government also imposed severe limits on how many rubles could be exchanged by Soviet citizens for hard currencies.) After the fall of the Soviet Union in December 1991, the ruble depreciated rapidly, while the purchasing power of the U.S. dollar was more stable, making it a harder currency than the ruble. A tourist could get 200 rubles per U.S. dollar in June 1992, and 500 rubles per USD in November 1992.
In some economies, which may be either planned economies or market economies using a soft currency, there are special stores that accept only hard currency. Examples have included Tuzex stores in the former Czechoslovakia, Intershops in East Germany or Friendship stores in the China in the early 1990s. These stores offer a wider variety of goods — many of which are scarce or imported — than standard stores.
Because hard currencies may be subject to legal restrictions, the desire for transactions in hard currency may lead to a black market. In some cases, a central bank may attempt to increase confidence in the local currency by pegging it against a hard currency, as is this case with the Hong Kong dollar or the Bosnia and Herzegovina convertible mark. This may lead to problems if economic conditions force the government to break the currency peg (and either appreciate or depreciate sharply) as occurred in the 1998–2002 Argentine great depression.
In some cases, an economy may choose to abandon local currency altogether and adopt another Fiat money as legal tender in a process known as dollarization. Examples include the adoption of the US dollar in Panama, Ecuador, El Salvador and Zimbabwe and the adoption of the German mark and later the euro in Kosovo and Montenegro.
- Review of the International Role of the Euro (PDF), Frankfurt am Main: European Central Bank, December 2005, ISSN 1725-2210ISSN 1725-6593 (online).
- For 1995–99, 2006–12: "Currency Composition of Official Foreign Exchange Reserves (COFER)" (PDF). Washington, DC: International Monetary Fund. January 3, 2013.
- For 1999–2005: International Relations Committee Task Force on Accumulation of Foreign Reserves (February 2006), The Accumulation of Foreign Reserves (PDF), Occasional Paper Series, Nr. 43, Frankfurt am Main: European Central Bank, ISSN 1607-1484ISSN 1725-6534 (online).