Tachyon Flare
06-27-2003, 05:32 PM
The Possibility of a Currency Attack
Although there is great deal of discussion concerning speculation, little attention is focused on the forex market (foreign currency exchange market). The reality of current monetary system is clear, in 1977, the daily forex had an average volume of $ 270 billion a day, today according to the Wall Street Journal it is roughly 2 trillion. Most estimates range between 1.5 to 3.4 trillion dollars a day, which is roughly one day in FX is equal to 75 Days on the NYSE! Several institutions have estimated that by 2005 the forex will reach approximately 6.5 trillion trading volume per day. The forex market activity is vastly greater than the Stock Market! It is estimated that 95% of all FOREX transactions are made for speculative purposes. Clearly, this is a problem, although the ephemera of day-to-day life of currency manipulation, speculation and arbitrage can be extremely profitable, it comes at the expense of the productive sector. More than 87 countries been affected by currency crisis, yet why is so pervasive? There is no doubt that after the collapse of the Bretton Woods, the philosophy of Milton Friedman & Company (1953, The Case for Flexible Exchange Rates) catapulted the world economy into perpetual chaos.
Let us take a recent example of a recent currency crisis, the so-called “Asian crisis.” Malaysia had an average GDP of almost 8.5% per annum, 38% savings rate, one of the highest foreign direct investments, relatively low percentage non-performing debt, however Malaysia did have substantial deficit in balance of payments, yet nothing too serious. Although Mahathir Mohamad blames currency speculators, there is no consensus on the cause however the fundamentals of the economy were strong, yet once economy became destabilized the KLSE (Kuala Lumpur Stock Exchange) index lost over 80 % value in less than 2 years, the ringgit lost 40% of its value in half year! Various other East Asian currencies went through similar mass devaluations, the Indonesian Rupiah against the US dollar was 2431 in July of 1997, and by 1998, it was more than 12,000! The foreign currency speculators who no doubt exacerbated the crisis profited at the expense of the East Asian countries. Not only these countries faced outflow of capital but also short selling of their stock markets, this created a downward spiral that required these countries to take drastic measure.
The Asian tigers were growing at a fantastic rate; the criticisms after the Asian crisis is greatly exaggerated. The US faces radically different fundamentals than these East Asian countries. This country faces a growing trade deficit, state deficits, massive debt obligations, inflated housing prices, a potential banking crisis (astonishing derivatives exposure), pension crisis, increasing unemployment rate, corporate layoffs, low savings rate, declining manufacturing base, high percentage of non performing loans, decline in real wages, loss of purchasing power, the list goes on and on . . . .
Before I get carried away, let me quote from “The Malaysian Currency Crisis” that attempts to explain the anatomy of the Malaysian currency attack:
“The Minister of Finance did not fully understand the concept of offshore ringgit. He thought that the term 'offshore ringgit' referred to the physical ringgit overseas, mainly in Singapore. The central bank either did not enlighten him or it too did not understand. In any case, the central bank did not stop the Minister and the government from instructing Customs officials to search travellers crossing the border for cash on their persons. This silly action did not stop the ringgit from going abroad and being traded.
The difference between offshore ringgit and domestic ringgit is not whether the ringgit is physically in Malaysia or outside Malaysia. Except for small amounts of cash held by moneychangers and banks, the ringgit will always be in Malaysia physically. When the ringgit is sold by a non-resident to another non-resident, all that happens is a change in ownership from the seller to the buyer in the accounts of the Malaysian bank and the foreign bank. No cash changed hands, only book entries in the banks of the buyer and seller changed.
When the currency trader borrows the ringgit, the same thing happens. The lender, usually a foreign international bank, merely transfers the ownership of the ringgit to the borrower in the books of the bank and the Malaysian bank holding the ringgit. The trader can then short the ringgit, delivering only after the ringgit has devalued, again through transfer to the accounts of the buyer.
Being able to leverage by 20 times their capital explains the strength of the hedge funds, i.e. they use a geared position to fight the central banks which use only their cash position. The hedge funds also tend to act together, buying and selling to each other and appreciating or depreciating the ringgit as they wish in order to maximize their profits. They do not buy the ringgit or any other currency in order to pay for goods or services. They really have no use for the money except to speculate and manipulate it. For them, money is a commodity like any other commodity traded on commodity exchanges. As in commodity futures, the physical existence of the currency is not important.”
How were they able to prevent continued attacks? Eliminating the offshore ringgit market, capital exchange controls like 12 month ruled imposed prohibiting repatriation of portfolio funds to prevent financial instability, pegging the ringgit to the US dollar and various other measures.
Let us look at a fairly well documented currency speculator George Soros. Allow me to quote Democratizing Globalization by Heikki Patomak:
“His 1992 attack on British Sterling was perhaps more ideologically than financially motivated, but it brought him more than US $1 billion in profits. In 1990, the UK had joined the European Exchange Rate Mechanism (ERM). By 1992, the Major government was increasingly unhappy with the situation: subordination to the policy of the Bundesbank, overvalued sterling and the recession caused growing popular dissatisfaction. Soros decided to bet on a crisis and to do everything possible to provoke it. Quantum Fund quietly established credit lines that would allow it to borrow about US$15 billion-worth of British pounds and to convert that sum into dollars at will. Once already long in dollars and short in pounds, Soros turned the attack noisy. He publicised his short-selling, and made statements in newspapers declaring that the pound would soon be devalued. It worked. The attack began in August; in late September Britain dropped out of the ERM, and the pound was set floating.”
Soros ultimately profited at the expense of British citizens. He has publicly disclosed (May 2003) that he now has short position against the dollar. No doubt, he will borrow US dollars just as he borrowed the British pound … no doubt the Fed will give him a great interest rate.
What does this have this to do with anything? EVERYTHING!
I am trying to point out is that if a countries like Malaysia or Japan can experience a financial turmoil under a fairly strongly fundamentals, how do you suppose the US economy can possibly survive under weak fundamentals? If the ringgit lost 40% of its value in half a year, what is the possible scenario for the dollar? This is not to say the dollar collapse is inevitable, if proper measures are taken by introducing the gold reserve system as well as government controlled bankruptcy reorganization and reinstituting the Glass Steagall Act and the Depository Institution Deregulation & Monetary Control Act, most of the economic turmoil can be avoided. There is no way that the US can possibly follow the solutions of Malaysia simply because the dollar is a world reserve currency, yet if radical measures are not taken, the tsunami power of the forex market along with short sellers will have unimaginable consequences (if memory serves, 50% of the household are still invested in the stock market). Once again, the forex market activity is vastly greater than the Stock Market! Expect the forex market to grow exponentially as US economy begins to destabilize! Thailand and Malaysia were able to recover from a currency collapse but it is highly unlikely the US will be able to recover because of lack of fundamentals. Most currency collapses do not end well, more than likely they end up like Mexico and Argentina.
Last thing I want to mention, there are proposed solutions that prevent currency speculation from destabilizing local economies One solution is the Tobin tax which is a low tax rate for normal transactions and an exchange surcharge on profits from very short-term transactions deemed to be speculative attacks on currency. The advocates for the Tobin tax argue that this can implemented by governments and non-governments organizations (BIS, IMF, World Bank) to stabilize the current monetary regime, however there is a huge disadvantage, Tobin tax cannot distinguish between liquidity trading and speculation. Personally speaking, although the intentions of such a system are reasonable, it is an attempting to patch up flaws into an innately unstable monetary system. It is not in the interest of oligarchies to implement exchange rate controls, or any form of taxes that discourage them from exploiting and profiting from the current fluctuating system. The current neo-Keynesian Friedamite economic policy makers truly need to change there entire belief system in order to prevent any systemic crisis …. Yet how can the proponents of Keynesian economics be trusted when he himself lost a fortune in the 1920s on speculation? Here is what interestingly Keynes writes about speculation:
"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done."
In summary, the forex market and hedge funds can leverage an enormous amount of monetary power with low margin requirements; a consolidated short selling by various financial institutions with high financial leverage and immensity of the daily volume of the forex can effectively hemorrhage a country to its knees. Central Banks can attempt to intervene by either buying or selling to counteract speculators yet at some Fed’s reserves would quickly deplete. This is not to say the forex market will initiate an economic collapse, no one can possibly know the trigger but once the herd takes aim, at some point it would be difficult for the Federal Reserve [Even the Financial Stability Institute (FSI http://www.bis.org/fsi/ (http://www.bis.org/fsi/)) and the Financial Stability Forum (http://www.fsforum.org (http://www.fsforum.org/))] to counteract such forces.
I would appreciate any comments, criticism, or point out any glaring mistakes. Please feel free to point out any blatant sophistry, illogical assumptions or rash oversimplifications. =)
I would like to end my ranting by two quotes:
“Looking back at what we did achieve in Asia over the last three decades, my heart naturally aches to see how swiftly and brutally this could be destroyed. The end of an era of Asian pride and newly won self-esteem came abruptly. We cannot move on without knowing why this had to happen. We cannot regain our faith in the future or return to the vision for a new millennium unless we discover how to defend ourselves against the forces of sudden economic ambush.”
- Mahathir Mohamad
"The obvious danger in such a regime resides in its potential instability. Some limited loosening is by no means unequivocally undesirable. It can be seen as a rational response to the earlier tendency, which was most manifest in the 1960s, for economic integration to run far ahead of both actual and desired political integration, thereby forcing countries into suboptimal policy choices. A degree of controlled disintegration in the world economy is a legitimate objective for the 1980s and may be the most realistic one for a moderate international economic order. A central normative problem for the international economic order in the years ahead is how to ensure that the dis-integration indeed occurs in a controlled way and does not rather spiral into damaging restrictionism."
-Fred Hirsch and Michael Doyle
Although there is great deal of discussion concerning speculation, little attention is focused on the forex market (foreign currency exchange market). The reality of current monetary system is clear, in 1977, the daily forex had an average volume of $ 270 billion a day, today according to the Wall Street Journal it is roughly 2 trillion. Most estimates range between 1.5 to 3.4 trillion dollars a day, which is roughly one day in FX is equal to 75 Days on the NYSE! Several institutions have estimated that by 2005 the forex will reach approximately 6.5 trillion trading volume per day. The forex market activity is vastly greater than the Stock Market! It is estimated that 95% of all FOREX transactions are made for speculative purposes. Clearly, this is a problem, although the ephemera of day-to-day life of currency manipulation, speculation and arbitrage can be extremely profitable, it comes at the expense of the productive sector. More than 87 countries been affected by currency crisis, yet why is so pervasive? There is no doubt that after the collapse of the Bretton Woods, the philosophy of Milton Friedman & Company (1953, The Case for Flexible Exchange Rates) catapulted the world economy into perpetual chaos.
Let us take a recent example of a recent currency crisis, the so-called “Asian crisis.” Malaysia had an average GDP of almost 8.5% per annum, 38% savings rate, one of the highest foreign direct investments, relatively low percentage non-performing debt, however Malaysia did have substantial deficit in balance of payments, yet nothing too serious. Although Mahathir Mohamad blames currency speculators, there is no consensus on the cause however the fundamentals of the economy were strong, yet once economy became destabilized the KLSE (Kuala Lumpur Stock Exchange) index lost over 80 % value in less than 2 years, the ringgit lost 40% of its value in half year! Various other East Asian currencies went through similar mass devaluations, the Indonesian Rupiah against the US dollar was 2431 in July of 1997, and by 1998, it was more than 12,000! The foreign currency speculators who no doubt exacerbated the crisis profited at the expense of the East Asian countries. Not only these countries faced outflow of capital but also short selling of their stock markets, this created a downward spiral that required these countries to take drastic measure.
The Asian tigers were growing at a fantastic rate; the criticisms after the Asian crisis is greatly exaggerated. The US faces radically different fundamentals than these East Asian countries. This country faces a growing trade deficit, state deficits, massive debt obligations, inflated housing prices, a potential banking crisis (astonishing derivatives exposure), pension crisis, increasing unemployment rate, corporate layoffs, low savings rate, declining manufacturing base, high percentage of non performing loans, decline in real wages, loss of purchasing power, the list goes on and on . . . .
Before I get carried away, let me quote from “The Malaysian Currency Crisis” that attempts to explain the anatomy of the Malaysian currency attack:
“The Minister of Finance did not fully understand the concept of offshore ringgit. He thought that the term 'offshore ringgit' referred to the physical ringgit overseas, mainly in Singapore. The central bank either did not enlighten him or it too did not understand. In any case, the central bank did not stop the Minister and the government from instructing Customs officials to search travellers crossing the border for cash on their persons. This silly action did not stop the ringgit from going abroad and being traded.
The difference between offshore ringgit and domestic ringgit is not whether the ringgit is physically in Malaysia or outside Malaysia. Except for small amounts of cash held by moneychangers and banks, the ringgit will always be in Malaysia physically. When the ringgit is sold by a non-resident to another non-resident, all that happens is a change in ownership from the seller to the buyer in the accounts of the Malaysian bank and the foreign bank. No cash changed hands, only book entries in the banks of the buyer and seller changed.
When the currency trader borrows the ringgit, the same thing happens. The lender, usually a foreign international bank, merely transfers the ownership of the ringgit to the borrower in the books of the bank and the Malaysian bank holding the ringgit. The trader can then short the ringgit, delivering only after the ringgit has devalued, again through transfer to the accounts of the buyer.
Being able to leverage by 20 times their capital explains the strength of the hedge funds, i.e. they use a geared position to fight the central banks which use only their cash position. The hedge funds also tend to act together, buying and selling to each other and appreciating or depreciating the ringgit as they wish in order to maximize their profits. They do not buy the ringgit or any other currency in order to pay for goods or services. They really have no use for the money except to speculate and manipulate it. For them, money is a commodity like any other commodity traded on commodity exchanges. As in commodity futures, the physical existence of the currency is not important.”
How were they able to prevent continued attacks? Eliminating the offshore ringgit market, capital exchange controls like 12 month ruled imposed prohibiting repatriation of portfolio funds to prevent financial instability, pegging the ringgit to the US dollar and various other measures.
Let us look at a fairly well documented currency speculator George Soros. Allow me to quote Democratizing Globalization by Heikki Patomak:
“His 1992 attack on British Sterling was perhaps more ideologically than financially motivated, but it brought him more than US $1 billion in profits. In 1990, the UK had joined the European Exchange Rate Mechanism (ERM). By 1992, the Major government was increasingly unhappy with the situation: subordination to the policy of the Bundesbank, overvalued sterling and the recession caused growing popular dissatisfaction. Soros decided to bet on a crisis and to do everything possible to provoke it. Quantum Fund quietly established credit lines that would allow it to borrow about US$15 billion-worth of British pounds and to convert that sum into dollars at will. Once already long in dollars and short in pounds, Soros turned the attack noisy. He publicised his short-selling, and made statements in newspapers declaring that the pound would soon be devalued. It worked. The attack began in August; in late September Britain dropped out of the ERM, and the pound was set floating.”
Soros ultimately profited at the expense of British citizens. He has publicly disclosed (May 2003) that he now has short position against the dollar. No doubt, he will borrow US dollars just as he borrowed the British pound … no doubt the Fed will give him a great interest rate.
What does this have this to do with anything? EVERYTHING!
I am trying to point out is that if a countries like Malaysia or Japan can experience a financial turmoil under a fairly strongly fundamentals, how do you suppose the US economy can possibly survive under weak fundamentals? If the ringgit lost 40% of its value in half a year, what is the possible scenario for the dollar? This is not to say the dollar collapse is inevitable, if proper measures are taken by introducing the gold reserve system as well as government controlled bankruptcy reorganization and reinstituting the Glass Steagall Act and the Depository Institution Deregulation & Monetary Control Act, most of the economic turmoil can be avoided. There is no way that the US can possibly follow the solutions of Malaysia simply because the dollar is a world reserve currency, yet if radical measures are not taken, the tsunami power of the forex market along with short sellers will have unimaginable consequences (if memory serves, 50% of the household are still invested in the stock market). Once again, the forex market activity is vastly greater than the Stock Market! Expect the forex market to grow exponentially as US economy begins to destabilize! Thailand and Malaysia were able to recover from a currency collapse but it is highly unlikely the US will be able to recover because of lack of fundamentals. Most currency collapses do not end well, more than likely they end up like Mexico and Argentina.
Last thing I want to mention, there are proposed solutions that prevent currency speculation from destabilizing local economies One solution is the Tobin tax which is a low tax rate for normal transactions and an exchange surcharge on profits from very short-term transactions deemed to be speculative attacks on currency. The advocates for the Tobin tax argue that this can implemented by governments and non-governments organizations (BIS, IMF, World Bank) to stabilize the current monetary regime, however there is a huge disadvantage, Tobin tax cannot distinguish between liquidity trading and speculation. Personally speaking, although the intentions of such a system are reasonable, it is an attempting to patch up flaws into an innately unstable monetary system. It is not in the interest of oligarchies to implement exchange rate controls, or any form of taxes that discourage them from exploiting and profiting from the current fluctuating system. The current neo-Keynesian Friedamite economic policy makers truly need to change there entire belief system in order to prevent any systemic crisis …. Yet how can the proponents of Keynesian economics be trusted when he himself lost a fortune in the 1920s on speculation? Here is what interestingly Keynes writes about speculation:
"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done."
In summary, the forex market and hedge funds can leverage an enormous amount of monetary power with low margin requirements; a consolidated short selling by various financial institutions with high financial leverage and immensity of the daily volume of the forex can effectively hemorrhage a country to its knees. Central Banks can attempt to intervene by either buying or selling to counteract speculators yet at some Fed’s reserves would quickly deplete. This is not to say the forex market will initiate an economic collapse, no one can possibly know the trigger but once the herd takes aim, at some point it would be difficult for the Federal Reserve [Even the Financial Stability Institute (FSI http://www.bis.org/fsi/ (http://www.bis.org/fsi/)) and the Financial Stability Forum (http://www.fsforum.org (http://www.fsforum.org/))] to counteract such forces.
I would appreciate any comments, criticism, or point out any glaring mistakes. Please feel free to point out any blatant sophistry, illogical assumptions or rash oversimplifications. =)
I would like to end my ranting by two quotes:
“Looking back at what we did achieve in Asia over the last three decades, my heart naturally aches to see how swiftly and brutally this could be destroyed. The end of an era of Asian pride and newly won self-esteem came abruptly. We cannot move on without knowing why this had to happen. We cannot regain our faith in the future or return to the vision for a new millennium unless we discover how to defend ourselves against the forces of sudden economic ambush.”
- Mahathir Mohamad
"The obvious danger in such a regime resides in its potential instability. Some limited loosening is by no means unequivocally undesirable. It can be seen as a rational response to the earlier tendency, which was most manifest in the 1960s, for economic integration to run far ahead of both actual and desired political integration, thereby forcing countries into suboptimal policy choices. A degree of controlled disintegration in the world economy is a legitimate objective for the 1980s and may be the most realistic one for a moderate international economic order. A central normative problem for the international economic order in the years ahead is how to ensure that the dis-integration indeed occurs in a controlled way and does not rather spiral into damaging restrictionism."
-Fred Hirsch and Michael Doyle