The international currency markets are as prone to be influenced by the fashion of the day as human beings. In the early '80s, the number in fashion used to be the US money supply. If memory serves me right, it used to come out on Wednesdays, and the dollar used to be bought and sold on the forex markets depending on whether the number was above or below market expectations. (Incidentally, I have read and heard the quoted phrase thousands of times without understanding it very precisely). If above, the dollar would be bought and appreciate. At that time, other macroeconomic fundamentals, the galloping trade deficit of the US for example, were not in fashion, and therefore overlooked. The fashion was in vogue for a few years, but for more than a decade now, I hardly remember seeing US M3 data in media reports on currency markets.
During the mid-'80s, the focus shifted to the Group of Seven (earlier G-5) central banks and what they would do: this followed the success of the G-7 in bringing the external value of the dollar against major currencies down by almost 50 per cent between, roughly, March 1985 to February 1987. When G-7 was in fashion, every communique used to be minutely examined to glean any hint of the central banks' intentions.
In the late '80s, the big mover of the exchange market was German unification. And this took the mark to record highs in dollar terms: I have never understood why! After all, unification with east Germany, that too at a 1:1 exchange rate between the west (Deutsche) and east (Ost) marks, was clearly likely to put enormous burdens on the German economy "" and it soon did, and led to fiscal deficits, high interest rates and current account deficits. But the euphoria over unification brooked no economic logic, and the mark went up and up.
From early 1994 to April 1995, the focus, for once, turned on the US trade deficit, particularly the bilateral one with Japan. To be sure, US politicians too were in a Japan-bashing mood. The result was a very sharp appreciation of the yen against the dollar, to Y 79 in April 95 from Y 112 in January 1994. It is worth noting that this sharp fall of the dollar was in the face of half a dozen increases in dollar interest rates engineered by the US Federal Reserve over the period. Contrast this with the recent arguments being advanced to explain the dollar's appreciation: by last Friday morning it had risen by 21 per cent against the mark and by 52 per cent against the yen since its low of April 95. The dollar rally against both these currencies has now lasted about 18 months. The reason, according to pundits, is the interest differential favouring the dollar. Why it did not work quite the same way from January 1994 to April 1995 is beyond me. Nor has the US trade deficit become less intractable. It has started growing again, but is not a fashionable number right now. The interest differential rationalisation is by no means confined to the dollar. Since last summer it has also been made applicable to the pound, its recent fall being attributed to the receding hopes of any pre-election rise in interest rates.
Perhaps Michael Lewis described the rationalisation best in his book Liars' Poker. The book is about his experiences with Solomon Brothers. As a trader he was expected to explain the gyrations in exchange rates. When nothing even peripherally plausible occurred to him, his reliable standby was the Arbs. (Remember, the book is about the '80s when OPEC had huge surpluses.) For example, the pound is going up because the Arabs have sold gold and are converting the dollars into sterling! He claims that this usually went off well because nobody knew what the Arabs were doing, let alone why! Incidentally, nobody interested in financial markets should miss the book: it is a superb read, free of fashionable hypocrisies and cliches.
The reality of course is more prosaic. The market is too efficient to be predicted, too chaotic for any mathematical models to hold. Today's accepted theory too often becomes tomorrow's heresy. The wise currency risk manager is rarely more ambitious than to appreciate, quantify and control risks through disciplined adherence to stop loss reversals.
Be that as it may, the international forex and derivatives markets are also witnessing major changes. Last year, hundreds of traders lost their jobs in London alone. One reason seems to be the electronic broking and trading systems introduced by EBS and Reuters which automatically match bid/offer prices, and execute traders, reducing the need for human action. Should the euro come into being as scheduled less than two years from now, thousands of intra-European currency traders and money chiggers will be out of jobs. Their hope may well lie in the possibility that trading volumes in some of the far eastern and east European currencies may increase as exchange controls get relaxed. Trading in the Malaysian ring, the Korean woo, the Thai baht, the Chinese yuan, the Polish zloty and the Bulgarian levy is growing. Again, consolidation of trading activity is taking place at many major banks. Citibank has reportedly confined currency trading to one dealing room in Europe; not long ago it had 15. Many smaller futures and options exchanges are finding that their business is falling and getting diverted to the bigger ones. More exchanges are forming alliances to trade each others' instruments. The future of Globex, Reuters' electronic trading system for derivatives, is in doubt. The only permanent thing in currency markets, whether in fashions or structures, seems to be change.