Forget Currency Trading for Dummies, or any of the other hundreds of guides that purport to teach you how to make a fortune buying and selling currencies on the Wild West frontier that is the global foreign exchange market.
For the best briefing on how the Forex market functions, look no further than the plea agreement between the US Justice Department and Barclays PLC, one of five major banks fined a record total of US$2.5 billion (Dh9.1bn) on May 20 for manipulating the exchange rates between the dollar and the euro, the world’s two most traded currencies.
The agreement, along with similar documents signed by the other four banks involved in the scam – Citicorp, JP Morgan Chase, Royal Bank of Scotland and UBS – spells out how for five years a group of unscrupulous currency traders conspired to boost their companies’ profits and their own bonuses “while harming countless consumers, investors and institutions around the globe”.
Helpfully, it also includes a concise guide to how the currency exchange market functions.
But don’t, says Steve Hanke, professor of applied economics at Johns Hopkins University, Baltimore, and director of the Troubled Currencies Project at the Cato Institute, Washington, be tempted to try this at home.
“For the amateur,” he says, “trading foreign exchange is a mug’s game of the highest order.”
Indeed, by the end of the plea agreement, you could be forgiven for thinking that the world has a multiplicity of floating currencies for only one reason: to allow professional speculators with large amounts of money to make even more of the stuff by trading on the volatility of the exchange-rates – in the process buying, selling and occasionally bankrupting the hopes and dreams of the rest of us.
Of course, as we grind our teeth at the prospect of the members of the self-anointed “Cartel” profiteering at our expense (and, adding insult to injury, dodging prison time into the bargain), it is worth remembering that at some time or another most of us have been accidental speculators.
Among the many thousands planning to leave the UAE for this year’s great summer getaway will be many who, while queueing to buy various currencies at the airport Bureau de Change, will yearn wistfully for the convenience of a single global currency.
Yet while few of those swapping their dollar-pegged dirhams for pounds or euros will have followed the exchange rate trends in the weeks or months leading up to their purchase, some stand to benefit purely by chance, either as they buy, or when they come to sell excess currency on their return.
Likewise, many workers who regularly send money back to their home countries, often through a transfer bureau such as Express Money or UAE Exchange, have been benefiting from the strength of the dollar against Asian currencies, for example. A recent World Bank report said expatriate Indians worldwide sent home more than $70bn in 2014 – a major boost for India’s economy.
Over the past three years the dollar has bought an average of 59.3 rupees. But that reflects a range from a low of just 51.7 in October 2012 to a current rate in excess of 63.6 – a gain of more than 22 per cent.
Other currencies have proved equally volatile against the dollar. For example, over the past five years Filipinos working in the UAE have endured a roller coaster of highs and lows, a dollar buying 46.6 pesos in June 2010 but only a five-year low of only 40.5 in January 2013. This week, one dollar was worth about 45 pesos.
Many expats who regularly send money home will have wised up to the opportunities presented by swings in exchange rates and wilfully played the market.
Take sterling, for example. Many enjoyed large windfalls riding the crests of the pre-crash exchange-rate tsunamis that swept currency markets between 2007 and 2009. In November 2007, the dollar was worth only £0.47945 – a 10-year low. But by January 2009 it had peaked at £0.72564, a 51 per cent increase and an exchange rate about which UK expats in the UAE still grow misty-eyed, but which has yet to be replicated.
Of course, this level of speculation is less than chicken feed in a currency exchange market that is, according to the US Department of Justice charge sheets against the five guilty banks, worth anything north of $2 trillion a day – by far the largest trading market in the world, including stocks.
One of the most famous currency trades ever executed was carried out in 1992 by hedge fund manager George Soros, and, in some quarters, it made him infamous.
In effect, he bet $10bn that the UK’s pound would not be able to maintain parity with the German mark, and so would crash out of the Exchange Rate Mechanism, a currency-harmonising system set up by the European Union as part of the run-up to the introduction of the euro single currency in 1999.
Soros’s $10bn intervention was on such a scale that it amounted to wish fulfilment, defeating the UK government’s attempts to shore up the pound, nudging the currency into crisis and earning him $2bn in a single day.
"The British called September 16 Black Wednesday," wrote Robert Slater, in his 1997 book Soros – The Unauthorised Biography. "Soros called it White Wednesday." The act was entirely legal, but it caused financial chaos for ordinary people who were dependant upon pensions and investments. As American Thinker noted in a 2008 article, Soros had made his killing "by shorting the British pound with leveraged billions in financial bets, and became known as the man who broke the Bank of England", breaking it "on the backs of hard-working British citizens who immediately saw their homes severely devalued and their life savings cut drastically in comparative worth almost overnight". However, it has also been argued that sterling's unplanned exit from the ERM kick-started a UK economy that had been languishing in recession, unable to undo the damage of being pegged to a surging German mark.
Some have speculated that there was a longer term, and even more sinister motive behind the actions of Soros and the other speculators who circled sterling like sharks on September 16, 1992 – the sabotaging of Europe’s plans for a single currency, which, at a stroke, would remove several profitably tradable currencies from the exchange market.
But Bernard Lietaer, the Belgian economist who co-designed the convergence mechanism that led to the euro, dismisses such conspiracy theories. “I happen to know George Soros,” he says. “I think he didn’t care, frankly. His only purpose was to make money – and he did.”
Nevertheless, the episode shocked Lietaer at the time: “It was an eye-opener to me, that a single guy in a market could do that.”
The euro survived, albeit without Britain on board. And, despite the ongoing crisis in Greece and the constant debate over the euro’s weak foundations, the very existence of a single European currency demonstrates exactly what ought to be possible on a global level.
The euro was introduced on January 1, 1999. Before then, in its place were 19 separate currencies, each rising and falling against the other on the tides of market whims and speculation.
So why shouldn’t the entire world follow suit and have a single currency?
In a sense, it already has, says Professor Hanke. “The reality is that we have a dominant international currency, the US dollar, and the reason that it dominates is that it is basically cheaper and more efficient to have one international unit that’s widely used as a transactions vehicle.”
There has been such a dominant currency from the 15th century onwards, since when the baton has passed in turns through the hands of Portugal, Spain, Netherlands, France and Britain, which reluctantly conceded dominance to the US in the early 20th century. The average lifespan of the dominant currency has always been about 300 years, says Hanke, “so by historical standards the dollar has a ways to go yet”.
Hanke would dearly love to see the bulk of the world’s 100-or-so currencies tossed in the bin. “Most of them don’t amount to much of anything,” he says, and the nations concerned would be better off either adopting the dollar or at least pegging to it, as the UAE and the other GCC states have done. Part of the problem, he says, is that currency is as much a political as an economic issue, and many countries hold on to their national money for no better reason than “the rhetoric of sovereignty”.
But there is, he says, another reason states like to hang on to their own currency: “Because the central banks who issue the money make money on it.”
This is what is known as seigniorage profits. In printing more paper money, nations are, in effect, borrowing money on which they don’t have to pay any interest.
For Lietaer, multiple currencies, and the traders who speculate on them, are a necessary evil, but only up to a point. He and his colleagues have been studying natural eco-systems and applying conclusions drawn from them to economic and currency theory.
“We now know there is a minimum level of diversity needed in any complex flow network in order for it to be stable,” he says. “A single currency would be more efficient, no question about that. But it would not be resilient.”
He believes that without currency speculation “you would have a much less liquid market, so the price formation would be a lot bumpier”.
But there must be limits to such activity.
As part of a widely diversified career in all aspects of money, including spells in academia and at the pre-euro central bank of Belgium between 1987 and 1991, Lietaer “became poacher” and headed up one of the world’s largest currency trading funds. In the process, he stumbled on a slightly scary secret.
“The problem with currencies is that speculation now accounts for 98 per cent of their value,” he says.
It is an astonishing thought. It means that the foundations upon which currency values are supposedly built – the hard figures of trade and GDP – are next to irrelevant when set aside the nebulous and easily manipulated concept of ”market sentiment”.
The tail, in other words, is wagging the dog – and has been doing, says Lietaer, for decades.
But while introducing a single global currency would end speculation overnight, says macroeconomist Jeffrey Frankel, the James W Harpel professor of capital formation and growth at Harvard Kennedy School, it would be neither practical nor desirable.
“I am sympathetic to the idea that banks profit excessively from exchange rate volatility,” he says. But there are “big important advantages” for national economies in having separate currencies – chief among them “the ability to set individual national monetary policies suited to national economies”.
It is, he says, true that some members of the financial community are speculators who profit from volatility but, as unpalatable as that might be to some of us, it is “just a tiny piece of a big complicated puzzle”.
Having a single global currency “would have some advantages and there are some long-term visionaries, including some good economists, who think that’s a worthy long-term goal”. But the idea will remain an unworkable fantasy, “unless and until the day comes when countries are ready politically to cede a lot more sovereignty to some federal world institutions, and we’re nowhere near ready for that”.
For it to work, all nations would have to be willing to live with a single monetary policy, “despite widespread differences in interests, economic situation, priorities and perceptions”. Even within the limited set of GCC countries “plans for monetary union have been put on hold, because it is just too difficult. Think how much harder it would be for a broader set of countries, let alone the whole world”.
Nevertheless, while it would be “naive and simplistic” to think that introducing a single global currency would solve all the evils of the banking system, he believes the time has come to recognise there is something distinctly off about the currency market.
“The volume of trading in foreign exchange markets is just huge, and long before we knew anything about this scandal of the price fixing there was this question: ‘Why is the trading so much greater than the volume of exports or imports?’.”
In theory, currency trading exists so individuals or institutions can buy foreign currency when they want to import something. But the scale of the currency exchange market dwarfs the size of the import-export market.
“People who really believe in free markets might say, well, this is the way that the free market has chosen to organise itself so it must be that this is the best way of assuring there’s enough liquidity and minimising the cost to the ultimate customer, the one who does need to buy foreign exchange for imports,” says Frankel.
“But after everything that’s happened with the global financial crisis and the more recent scandals with the price fixing, I don’t think they’re entitled to that presumption any more.”
Meanwhile, in their own small way, expats working in the UAE continue to appreciate the power of the global currency market to magic-up money out of thin air.
If they’re wise, an expatriate sending money home to the UK or elsewhere in Europe – in effect, buying pounds or euros with dollars – will keep an eye on currency trends. Rather than robotically sending home the same amount on the same day every month, they will dispatch their cash only when the exchange rates are most favourable.
Study the form over the past year or so, for example, and it is clear that the relationship between the dollar and the rest of the world’s major currencies remains sufficiently volatile for money to be made in the gaps that open and close between them.
For example, in the past year the strength of the dollar against the pound grew steadily. The “low” point, from a UK perspective – and a five-year low, at that – was just over a year ago, on July 2, 2014, when $1 was worth only £0.58283.
By April 10 this year, however, the sterling value of one dollar, climbing steadily over the months, had risen to £0.68332. This meant that a British expat with $10,000 to send home would have banked £5,823.83 had they done so in July last year – but £6,833.20 if they’d waited until this April.
They would, in other words, have “earned” a profit of £1,009.37 – equivalent to an unheard-of interest rate of 17.35 per cent.
Not bad for doing nothing.
Jonathan Gornall is a freelance journalist based in London.