Today, the real economy in foreign exchange transactions is down to
2.5 percent and 97.5 percent is now speculative. The real economy
has become just a small percentage of total financial currency activity.
Bernard Lietaer's estimate for 1997 was that close on $2 trillion in
currencies being traded each day. This is equivalent to the entire
annual gross domestic product (GDP) volume of the United States being turned
over via currency trading every three days.
There are three cumulative causes for this explosive increase in currency speculation.
Systematic redefinition.
The first important act was former President Richard Nixon's unleashing
of the dollar standard in 1973. "Floating" the dollar allowed currency
values to be determined by traders in currency exchange markets.
Currencies from countries with strong economies and sound monetary
and fiscal policies were given more value than currencies from weak countries.
Legal deregulation.
In the 1980's both Ronald Reagan and Margaret Thatcher introduced deregulation
strategies. The Baker Plan, implemented by the World Bank and the International
Monetary Fund (IMF), applied those changes to a dozen key Third World countries.
This created a lot more leeway for movement of capital internationally,
and for corporations that previously would not have participated in speculation.
Technology.
The structural, deep-lying phenomenon behind the whole system, is the
technological shift: the electronification of money and the computerization
of market systems.
THE BUSINESS VIEWPOINT.
Economic textbooks say that corporations and individuals compete for markets and resources. This is not true. Corporations and individuals compete for money, by using markets and resources.
The opening of the stets which led to "floating exchanges," also created a new asset class. Traditional asset classes are real estate, bonds, stocks, and commodities. Today we also have currencies. this means that money, the medium of exchange, has itself become an asset to be played into investment portfolios. This shift has different implications for businesses, depending on whether you're an investor or a "real" business.
From an investors viewpoint, this new asset class--currencies--has some significant advantages over the old ones.
* Extraordinarily low transaction costs. Placing a few billion dollars in foreign exchange costs very little, as much as ten or twenty times cheaper than a stock transaction.
* Twenty-four hour market environment; one can actually play around the clock.
* The foreign currency market is the largest and deepest market around
by a long shot. If you have a few billion dollars to place, bringing them
to the stock market is going to move the stock's value and tip-off other
traders as to what you are doing. this is true in most bond markets (except
for the US and some European markets because of their large size). In foreign
exchange, even five or ten billion won't make a blip.
So if you have a substantial amount of money to move around, this is
the place to do it. You can get in and out without affecting the market.
Because of these three advantages, the act of lending money to people (to buy houses, cars, expand businesses, or whatever) is no longer the best way to make money. The foreign currency market is the place to do it.
Banks are no longer the big players in terms of supplying credit. In the last twenty five years, banks as a source of financing in America, have dropped from 75 percent of the total supply of credit to 26.5 percent. For the major international banks, like Chase Manhattan, Citicorp, Bank of America, Barclays or Sumimoto, currency trading typically accounts for at least 20 percent of total earnings. In a good year, it will be more than 50 percent.
* * *
In considering the viewpoint of so-called real business (those that make cars, mine, produce electronics etc.), the "foreign exchange risk" has by far become the largest risk in international business today, often larger than political or market risk. For example, if a German chemical company invests in a plant in India, it makes the investment in deutschmarks. The chemical products sold locally from the plant are paid in rupees, India's currency. If the value of the rupee then drops in terms of the deutschmark, the return on the original investment will drop as well. In short, the biggest risk of such investment is not whether Indians will buy the chemicals (market risk), but the changes in the values of the currencies involved (foreign exchange risk).
Corporations have followed two major strategies to deal with this risk.
The first strategy is the reorganization of the corporate conglomerate.
Production and marketing sectors are decentralizing because the risk
doesn't lie there, and because adaptation to local circumstances can best
be handled on a local level. This also leads to the dispersal of production
facilities to other countries. But while marketing and production are decentralizing,
the corporation's financial and treasury functions are being centralized.
Twenty or thirty years ago, when an American company had a big plant in
Germany, the plant would handle its own finances. not any more. Now this
is all done centrally at corporate headquarters.
The second strategy that large corporations pursue is an adjustment of their executive officers. In the 1940's and 1950's, anybody who could manufacture any product could sell it. So a manager with a background in production or engineering would typically become the CEO. In the 1960s and 1970s, that shifted. Suddenly marketing was the key background necessary for people at the top. However in the 1980s and 1990s, finance specialists are in charge. They are the ones who call the shots. That shift in career paths has also changed the corporations outlook, and is a reaction to the new risk that we are talking about.
* * *
Now I have two questions for you.
First: who do you think is the largest private financial institution in the US today? It is General Electric (GE). The largest profit sector in GE is not defence, not light bulbs, not power stations. It's GE's treasury department, because of its many financial transactions.
The second question is: Who do you think is taking the largest foreign exchange risk? It's everybody who holds only one currency. That is most people. Anyone who owns their own house, which sits in one currency and who has their savings and income in the same currency, is at the greatest risk. By holding only one currency, they risk all their assets being devalued in the event of their currency crashing. In a world of floating exchanges, not being diversified in currencies is like having a stock portfolio with only one stock.
The first consequence of this state of affairs is that national governments are in the process of losing power. The nation-state is the one entity that cannot manage in this new climate. It has no way to gain power against global capital and information technology.
Currency traders are effectively "policing" governments by selling off a nation's currency when they are dissatisfied with the government's policies. If enough traders act together, the value of a currency can plummet, creating a "currency crisis". These suddenly large sell-offs are viewed by governments as "attacks" on the value of their currencies.
Currency devaluation can happen in a very short time, days or even hours, because of the new global communications system. There are no negotiations, there's no talking, there's nobody sitting around a table saying "This is what we are going to do", or "How about renegotiating this part?" That's not the way it happens. You just suddenly end up with a crisis in a particular country's currency. Such was the case with the collapse of the British pound sterling in 1991, the Scandinavian currencies in 1992 and 1993, and Mexico in 1994.
One of the things to watch for in the future will be such a devaluation of (an "attack" on) the US dollar, which is the linchpin of the whole system. Now, one might ask, "Why would traders want to pull out the linchpin?" Well, from an individual traders point of view, it doesn't matter which currency you profit from, you just trade. If enough traders see an opportunity to profit by the dollar's fluctuations, they will exploit it, because nobody believes his or her individual action will bring down the entire system.
Central banks can often intervene when a currency is under attack by either buying or selling to counter speculators. But the volumes of money now being traded are so vast that even central banks may not have an impact. All the reserves of all the central banks together amount to $640 billion, so all their reserves could be depleted in a third of a normal trading day.
This points directly to a second consequence: a growing interest in market instability because that is where one finds the opportunity for windfall profits. Big fluctuations in the values of currencies allow for big profits to be made by trading them. Consider the following statements by leaders at opposite ends of the spectrum.
"The biggest concern today is the growing constituency for instability" -- Paul Volker, ex-governor of the Federal Reserve, in Changing Fortunes.
"Instability is cumulative, so the breakdown of freely floating exchanges is ensured" -- George Soros, the largest currency speculator today, in The Alchemy of Finance.
They both agree that there are many people now who have an interest in profiting from instability; previously they had an interest in stability. If you have an unstable system, it is just a question of when will it fly off the handle. It will blow apart at the moment when the US dollar experiences a crisis. When the dollar crisis occurs, the world will have no system left.
The only precedent I know is the collapse of the Roman monetary system. In the 1920 crash, the monetary system held. We had all kinds of other problems--unemployment, stock market crashes, currency inflation in Germany--but there was a gold standard which held. Today, we have no gold standard to fall back on. So there is no precedent for a collapse of this nature. And this would be a truly global phenomenon. All currencies in the world are based on the dollar. So if you have a crisis on the dollar, you pull out the linchpin and....boom.
The third consequence is something with which we are very familiar. As a great portion of the national currencies--about $2 trillion per day--is being turned around in the financial cyber-economy, there is just no satisfactory medium of exchange available to people at the bottom. National currencies are not widely available to the poorer parts of the population. The age of labour as a key component of production is gone. If you don't have a job, you don't have "money" (i.e. national currency)
Even despite the fact that structural unemployment is increasing, the economy can continue to "grow" very well. Technology will shift us still further in that direction.
What is beginning to happen in the developed countries is a new phenomenon: an explosion of "local currencies"--money that is not the national currency. We haven't seen that since the Great Depression when there were literally thousands of local currencies in the US and other countries affected by massive employment. By supporting the development of local money schemes, we may in fact create the groundwork for the next system. This could become one of the most powerful ways available to support citizen control.
