Fiscal free-for-all

Roger St Pierre examines the ongoing rise, fall and vagaries of the volatile forex market, a sector to be explored with caution


Veteran show business impresario Jeffrey S Kruger knows a thing or two about the vagaries of the foreign exchange market, “Promoting concerts for the likes of Frank Sinatra, BB King and Jerry Lee Lewis to tour in Europe, I had to contract months ahead,” he recalls, adding, “I learned very early on that the difference between financial success and failure depended as much on exchange rate fluctuations as it did on getting bums onto seats.”

Once almost a sideline activity, forex has now become a major financial sector in its own right, with fortunes made or lost, sometimes overnight. The average daily turnover in foreign exchange markets across the world is now estimated to stand at around $3.98tn, according to the Bank for International Settlements, with the main financial markets accounting for the vast majority ($3.21tn) of this.

In the postwar period most countries followed the fixed exchange rate regime of the 1944 international Bretton Woods system, which had been devised to help deter the bank runs of the 1929 crash which had led to worldwide depression and a second world war, Then, from 1973 on, a foreign exchange market quickly developed as countries began to switch to floating exchange rates and the likes of the dollar and gold standards were consigned to banking folk memory.

Since those days, growth has been truly phenomenal. The key traders now include central banks, governments, commercial banks, other financial institutions such as insurance companies and pension and mutual funds, professional currency speculators, corporations and, increasingly – thanks largely to the internet and the lure of a possible fast buck – private investors.

Daily turnover of the global forex market now approaches a massive US$5tn, with volumes growing by 41 percent between 2007 and 2008, having shown an impressive six-fold growth since 1988. Much of this growth has been generated in Europe, with London accounting for a colossal 34.1 percent of global forex turnover, placing the City far ahead of New York (16.6 percent) and Tokyo (6.0 percent).

Seven of the top 10 global currency traders in the world in terms of overall volume are European institutions, including the top four.

The clear leader is Germany’s Deutsche Bank, with a potent 20.96 percent market share, followed by Switzerland’s UBS AG (14.5 percent), Britain’s Barclays Capital (10.45 percent) and Royal Bank of Scotland (8.19 percent). The other European banks in the top 10 are Britain’s HSBC, Switzerland’s Credit Suisse and France’s BNP Paribas. According to the 2008 Euromoney FX survey, the top 10 accounted for almost 80 percent of total trading volume, and they tend to set the ‘bid’ (buy) and ‘ask’ (sell) prices of the world market.

The playing field is not exactly level as, unlike with the stock market where everyone can access the same prices, there is a tiered system of access to the foreign exchange markets, with the big banks and securities traders benefiting from the best prices, thanks largely to the vast amount of trading they carry out – and they make up around 53 percent of the market. The world’s central banks use forex trading as a way to help control money supply, contain inflation and set interest rates while major multinational corporations use forex transactions to both hedge their risk and in order to pay employees working in different countries.

Of course, all this is a form of gambling, with as much as 85 percent of all transactions being on a wholly speculative basis, with traders hoping to buy and then sell on quickly – at a profit. Since emerging in the marketplace in the mid-nineties, hedge funds, which control billons of dollars worth of equity and may borrow billions more, have engaged in often highly aggressive currency speculation, often negating the efforts of central banks to support particular currencies and stabilise the economy.

A number of forex scams have led to tighter controls over retail forex brokers and market makers. The NFA and CFTC now impose much tighter regulation and the substantial amount of capitalisation now required has served to squeeze dubious operators out of the market. However, investors need to be aware that market makers are given to trading against their clients and often take the other side of their trades – practices that lead to
accusations of conflict of interest. That old codicil “Let the buyer beware” certainly applies.

According to a recent New York Times report: “The Forex market has long been plagued by swindlers preying on the gullible”. According to the CFTC, the average individual forex fraud victim loses some US$15,000.

Problems that have emerged include mismanagement, quack software, false advertising, Ponzi schemes and sheer fraud. However, at every level, forex is one financial sector that has continued to thrive despite the general global economic downturn and it has consequently served as a profitable silver lining for banks that have been struggling in their other activities.

These have been seesawing times, however, and October 2009 witnessed the dollar continuing to lose ground against the euro, hitting the critical US$1.50 level (and setting a 14-month peak at US$1.5061) while also weakening against the British pound. Canny investors have been borrowing in the low-yielding US dollar to fund their investments in higher-yielding currencies and assets, creating the so-called ‘carry trade’ phenomenon.
In the same month, the eurozone Purchasing Managers’ Index rose to 53.0 and there are now worries that if the euro’s gains become too strong, the impact on export prices will damage the long-awaited recovery. October also saw sterling gain 2.7 percent against the dollar, reaching US$1.6306, its strongest level since August.

Of course, the advent of the eurozone eliminated trading across the currencies of the countries that signed up but it at the same time created a single currency that has become a challenger to the dollar, the yen and the pound.

It’s fortunes are largely controlled by the European Central Bank, established in Frankfurt am Main, Germany, in June 1998 and now employing around 3,500 people, drawn from al 27 European Union member countries,
“One of our primary duties is to secure price stability in the euro area,” says ECB president Jean-Claude Trichet, adding, “The foreign exchange markets can have a major impact on that aim. The ECB works closely with the national central banks of all the euro area countries in a team called the Eurosystem and we work together as the ESCB – the European System of Central Banks. Our main objective is to ensure that prices remain stable.”