George Soros on the consequences of Brexit

George Soros in The Guardian

David Cameron, along with the Treasury, the Bank of England, the International Monetary Fund and others have been attacked by the leave campaign for exaggerating the economic risks of Brexit. This criticism has been widely accepted by the British media and many financial analysts. As a result, British voters are now grossly underestimating the true costs of leaving.

Too many believe that a vote to leave the EU will have no effect on their personal financial position. This is wishful thinking. It would have at least one very clear and immediate effect that will touch every household: the value of the pound would decline precipitously. It would also have an immediate and dramatic impact on financial markets, investment, prices and jobs.

As opinion polls on the referendum result fluctuate, I want to offer a clear set of facts, based on my six decades of experience in financial markets, to help voters understand the very real consequences of a vote to leave the EU.

The Bank of England, the Institute for Fiscal Studies and the IMF have assessed the long-term economic consequences of Brexit. They suggest an income loss of £3,000 to £5,000 annually per household – once the British economy settles down to its new steady-state five years or so after Brexit. But there are some more immediate financial consequences that have hardly been mentioned in the referendum debate.

To start off, sterling is almost certain to fall steeply and quickly if there is a vote to leave– even more so after yesterday’s rebound as markets reacted to the shift in opinion polls towards remain. I would expect this devaluation to be bigger and more disruptive than the 15% devaluation that occurred in September 1992, when I was fortunate enough to make a substantial profit for my hedge fund investors, at the expense of the Bank of England and the British government.

It is reasonable to assume, given the expectations implied by the market pricing at present, that after a Brexit vote the pound would fall by at least 15% and possibly more than 20%, from its present level of $1.46 to below $1.15 (which would be between 25% and 30% below its pre-referendum trading range of $1.50 to $1.60). If sterling fell to this level, then ironically one pound would be worth about one euro – a method of “joining the euro” that nobody in Britain would want.

Brexiters seem to recognise that a sharp devaluation would be almost inevitable after Brexit, but argue that this would be healthy, despite the big losses of purchasing power for British households. In 1992 the devaluation actually proved very helpful to the British economy, and subsequently I was even praised for my role in helping to bring it about.

But I don’t think the 1992 experience would be repeated. That devaluation was healthy because the government was relieved of its obligation to “defend” an overvalued pound with damagingly high interest rates after the breakdown of the exchange rate mechanism. This time, a large devaluation would be much less benign than in 1992, for at least three reasons.

First, the Bank of England would not cut interest rates after a Brexit devaluation (as it did in 1992 and also after the large devaluation of 2008) because interest rates are already at the lowest level compatible with the stability of British banks. That, incidentally, is another reason to worry about Brexit. For if a fall in house prices and loss of jobs causes a recession after Brexit, as is likely, there will be very little that monetary policy can do to stimulate the economy and counteract the consequent loss of demand.

Second, the UK now has a very large current account deficit – much larger, relatively, than in 1992 or 2008. In fact Britain is more dependent than at any time in history on inflows of foreign capital. As the governor of the Bank of England Mark Carney said, Britain “depends on the kindness of strangers”. The devaluations of 1992 and 2008 encouraged greater capital inflows, especially into residential and commercial property, but also into manufacturing investments. But after Brexit, the capital flows would almost certainly move the other way, especially during the two-year period of uncertainty while Britain negotiates its terms of divorce with a region that has always been – and presumably will remain – its biggest trading and investment partner.

Third, a post-Brexit devaluation is unlikely to produce the improvement in manufacturing exports seen after 1992, because trading conditions would be too uncertain for British businesses to undertake new investments, hire more workers or otherwise add to export capacity.

For all these reasons I believe the devaluation this time would be more like the one in 1967, when Harold Wilson famously declared that “the pound in your pocket has not been devalued”, but the British people disagreed with him, quickly noticing that the cost of imports and foreign holidays were rising sharply and that their true living standards were going down. Meanwhile financial speculators, back then called the Gnomes of Zurich, were making large profits at Britain’s expense.

Today, there are speculative forces in the markets much bigger and more powerful. And they will be eager to exploit any miscalculations by the British government or British voters. A vote for Brexit would make some people very rich – but most voters considerably poorer.

I want people to know what the consequences of leaving the EU would be before they cast their votes, rather than after. A vote to leave could see the week end with a Black Friday, and serious consequences for ordinary people.

China accuses George Soros of 'declaring war' on yuan

Billionaire investor ‘trying to create panic for profit’, says scathing editorial, after he predicted the Chinese economy is headed for a hard landing

 

George Soros said China had left it to late to move from an export to a consumer-led economy. Photograph: Pascal Lauener/Reuters


Agence France-Presse in Beijing

Wednesday 27 January 2016 06.04 GMT

Chinese state media has stepped up a salvo of biting commentaries against George Soros and other currency traders as the yuan comes under pressure, with the billionaire investor accused of “declaring war” on the unit.

At the annual World Economic Forum in Davos last week, Soros told Bloomberg TV that the world’s second-largest economy – where growth has already slowed to a 25-year low according to official figures – was heading for more troubles.

“A hard landing is practically unavoidable,” he said.

Global markets turmoil echoes 2008 financial crisis, warns George Soros



Soros – whose enormous trades are still blamed in some countries for contributing to the Asian financial crisis of 1997 – pointed to deflation and excessive debt as reasons for China’s slowdown.

The normally stable yuan, whose value is closely controlled by Beijing, has come under pressure in recent weeks and months in overseas markets and from capital outflows. Authorities have spent hundreds of billions of dollars to defend it.

China’s official Xinhua news agency on Wednesday said that Soros had predicted economic troubles for China “several times in the past”.

“Either the short-sellers haven’t done their homework or … they are intentionally trying to create panic to snap profits,” it said.

An English-language op-ed in the nationalistic Global Times newspaper blamed “westerners” for not “accepting responsibility for the mess” in the world economy.

The comments came after the overseas edition of the People’s Daily, the official mouthpiece of the Communist party, published a front-page article Tuesday titled “Declaring war on China’s currency? Ha ha” that was widely shared on Chinese social media.

Soros “publicly ‘declared war’ on China”, the paper said, citing the 85-year-old as saying that he had taken positions against Asian currencies.

But some readers questioned whether the official rhetoric could fuel Chinese investors’ fears.

“They say a lot of loud slogans, but do official media even know that Chinese investors are in hell?” said one poster on social media network Weibo.

“I’m afraid that Chinese investors will die in a stampede before Soros even shows his hand.”

In the 1990s Soros led speculators in bets against the Bank of England, which unsuccessfully sought to defend the pound’s exchange rate peg.

“The Chinese left it too long” to change their growth model from dependence on exports to a consumer-led one, Soros said, even though Beijing had “greater latitude” than others to manage such a transition because of its currency reserves, which stand at over US$3tn.

The Privatisation of Royal Mail: how hedge funds cleaned up

OLIVER WRIGHT  , JIM ARMITAGE , MARK LEFTLY

 The Independent

Tuesday 29 April 2014

The Royal Mail flotation scandal has deepened after officials finally admitted that hedge funds were among the “priority investors” sold hundreds of millions of pounds of shares.

The Business Secretary, Vince Cable, has repeatedly insisted that the handful of key investors offered Royal Mail shares on preferential terms were long-term institutional investors. This was to ensure the new company started with “a core of high-quality investors” who “would be there in good times and bad”. He promised to marginalise “spivs and speculators”.

But sources in the Department for Business have confirmed to The Independent that around 20 per cent of the shares it had allocated to 16 preferred investors had gone to hedge funds and other short-term investors. This would equate to around £150m of Royal Mail shares – 13 per cent of the entire stock sold by the Government. The companies bought in at the float price of 330p a share. The shares shot up within seconds of trading, eventually peaking within weeks at more than 600p, allowing the hedge funds to bank vast profits at the taxpayers’ expense.

Mr Cable is now under mounting pressure to name the priority investors given preferential deals in the form of extra-large share allocations, which his department has so far withheld citing commercial confidentiality. Unions have called for his resignation over the “botched” handling of the sale.

A recent National Audit Office report revealed that of the 16 priority investors, half had sold their shares within weeks of the flotation.

Vince Cable refuses to apologise over the losses, and says Royal Mail remains fragile (Getty)
Sources close to Mr Cable told The Independent that hedge fund involvement had been necessary to give the new stock “liquidity” and that the practice was entirely normal in share offerings. They added that they made up a small minority of the total share allocated to institutional investors.

But the revelation contrasts with Mr Cable’s previous statements on the sale. He has said institutional demand was so strong that the Government would be able to allocate shares to “responsible long-term institutional investors” rather than speculators.

An analysis of Royal Mail’s share register shows that Och-Ziff, an aggressive US-based hedge fund, had a holding of 10 million shares on 15 October, the day the company’s shares started trading. A week later it had reduced its holding to 3.5 million shares. It is not known if Och-Ziff was allocated shares or bought its holding from other institutional shareholders who sold out as soon as shares started trading.

Lansdowne, another hedge fund which is known for its close links to the Conservative Party, also appears to have received an allocation of around 18 million shares, at a cost of just under £60m. Lansdowne said the owners of the shares are Lansdowne’s clients not Lansdowne. It is understood that Lansdowne has not sold any shares.

The revelation that the Government knowingly sold off Royal Mail shares to hedge funds is likely to come under scrutiny today when the Public Accounts Committee questions the Department for Business’s Permanent Secretary and representatives of the investment banks who handled the sale on behalf of the Government.

The PAC will examine what advice was given by investment banks including Goldman Sachs, UBS and Lazard and why the shares were priced so cheaply. It will also demand to know why Lazard has been appointed to run the vast majority of major privatisations under the current Government following previous revelations by The Independent.

Shares in Royal Mail were floated on the London Stock Exchange last October (Getty)

Today in openly hostile exchanges with MPs on the Business Select Committee, Mr Cable refused to apologise over accusations that the Government sold Royal Mail on the cheap. He argued that the 360-year-old postal service remained “a fragile company”, despite becoming a City favourite since shares debuted in October.

Conservative committee member Brian Binley said that government advisers had underpriced the shares out of the “fear” of being unable sell them at a higher but more accurate valuation. “I don’t understand why you are being so obstinate about getting this right when you so palpably got this wrong,” Mr Binley admonished William Rucker, the chief executive at lead adviser Lazard.

Business minister Michael Fallon insisted that the Government had sold the shares “at the best price we possibly could have got at that particular time”. Committee chairman Adrian Bailey mocked this claim as “absolutely Alice in Wonderland”.

Mr Fallon also indicated postmen and women were partly to blame for the suppressed price of the sale, because the unions had “no interest in lifting the threat of industrial action”.

However, the Business Secretary conceded that he would have to take a close look at whether selling shares in the markets was the best way of privatising public assets.

He also promised to “reflect” on whether the full list of the 16 major institutional investors should be revealed. Mr Cable has agreed to privately hand the list to Mr Bailey.

Then and now: What Cable said

“We are in a position to ensure we do get the right type of investor community – pension funds, insurance companies that hold the savings of millions of people. That’s the type of community we want.”

Vince Cable to MPs in  October 2013. (At the same hearing he said the Government would be able to block shares from going to “spivs and speculators” in favour of “responsible long-term institutional investors”.)

“We wanted to make sure that the company started its new life with a core of high-quality investors who would be there in good times and bad, interested in  Royal Mail and the universal service it provides for  consumers over the long term. We were told if we sought a higher price, these investors would have walked away, leaving the company exposed to short-term  hedge funds with different objectives.”

Mr Cable in an interview in December 2013

“Having a long-term investor base remains a basic objective, and we  have achieved that fundamental objective.”

Mr Cable in the Commons on 1 April 2014

Warren Buffet - a Jaded Sage?

The jaded sage
By Chan Akya in Asia Times Online

Warren Buffett, besides being the Sage of Omaha and one of the wealthiest men to ever walk this planet, is also an American hero. A man who popularized the notion of investing your savings prudently, taking a knife to Wall Street excesses and more recently, the architect of an effective minimum tax for rich Americans. All in all, your regular billionaire next door.

Of course I can also recount all the reasons why anyone who bothered to print this article and read the first paragraph got disgusted, crumpled the paper into a little ball and threw it into the nearest waste bin.

You know, stuff like his holdings in major American scams like Moody's which he purchased due to the massive profits they were making from selling fake triple-A ratings all around. Or his rescue of such amazing firms as Goldman Sachs in the midst of the financial crisis, in effect protecting them not so much from aggressive market speculators but perhaps the major regulatory bodies as well (Mr Buffett is a known supporter of and donor to President Barack Obama).

Even that supposed act of folksy good humor ("my secretary pays a higher tax rate than I do") hides an ugly word: "legacy". Mr Buffett is old and if he had wanted to pay higher taxes, well he had the last 60 years in which to do it.

But I don't care about any of Mr Buffett's flaws any more than I lose sleep over that stupid woman who unfailingly puts mayonnaise on my sandwich despite being told not to every day. My getting upset doesn't change a thing, and just ends up spoiling my day: it's easier for me to just buy my sandwiches somewhere else. That's where I left Mr Buffett - that is, until his latest investment letter hit the web and through acts of generosity by my friends, made it into my inbox. Ten times over.

Cold on gold
I don't know why so many of them did that - but it may have something to do with his statements about irrational choices that investor make about assets. He writes:

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth - for a while.

Okay, so if I understand this right, Mr Buffett objects to the fact that gold cannot be manipulated, conjured up out of thin air and that it draws a bunch of people weary of Keynesian money printing into its fold. I am not going to suggest that Mr Buffett is thick or something, but isn't all of the above the very point about owning a store of value in the first place?

I don't know about you, but if I could travel through the centuries I would sure as hell like to have in my pocket something that would still be worth something in purchasing power that approaches its current value.

Imagine the following scenario: your grandfather leaves us some wealth but you only get it 50 years later. Now, what would you have liked that "wealth" to have been: cash in US dollars or gold coins? Of course other assets would have worked better - "shares in Apple" for example. Then again, if your grandfather had given you shares in Apple and you got them in 1998, your general feelings of gratitude towards him would have been a somewhat dimmer.

Then Mr Buffett goes on with his diatribe:

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce - gold's price as I write this - its value would be $9.6 trillion. Call this cube pile A. Let's now create a pile B costing an equal amount. For that, we could buy all US cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

... A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops - and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Yup, valid points there. Then, again Mr Buffett, I wonder how those farmers would pay for the oil to use in their harvesters and how those oil workers would pay for all the grains they would need to eat. Would they own shares in each other and pay the other party dividends in kind? Or would they transact with a common currency, like gold?

And all the analysis misses the point about corporate fraud, that uniquely American preoccupation that has seen many a top firm go completely bust because of financial and accounting shenanigans. If Mr Buffett had mentioned BP instead of Exxon (and written this article two years ago rather than now) he would have had egg on his face. (See also "BP, Bhopal and Karma", Asia Times Online, June 19, 2010, one of my past articles on the subject of corporate responsibility.

Mr Buffett misses the point entirely about what gold is and what it is supposed to do. In a world where investors have ample reason to lose faith in governments and the financial system, the position of a common store of value that is recognizable and usable across all humanity and is itself beyond religion and politics in terms of being manipulated around (besides being no mean feat by itself) is made stronger, not weaker.

That is not to say that I am recommending you folks to buy gold and nothing else; my view has always been that a building up a little hedge for your financial assets with physical gold is no bad thing. I don't speculate in gold nor do I believe you should.

Of course, he clarifies similar points later on his spiel as follows:

My own preference - and you knew this was coming - is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM and our own See's Candy meet that double-barreled test. Certain other companies - think of our regulated utilities, for example - fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets. Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See's peanut brittle. In the future the US population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Really? The best that Mr Buffett can conjure up as stores of "productive" assets are those that generate software consulting services, sugared water with noxious chemicals and over-sweet artificially flavored foodstuffs? Is it possible that all of these companies will even exist 200 years from now, or will a bunch of lawsuits or corporate fraud take one or more of them down as they have many an American corporation?

This is neither about questioning his investment choices nor indeed to taunt a proud American on that country's potential failings. The investor letter though is emblematic of the core ill plaguing the West now; namely a failure to question the current logic of organization underpinning the economy.

On the other end of the scale, it is not immediately apparent that a deleveraging America would need as many cans of sugared water with noxious chemicals as it does now; nor indeed that the current system of savings through stocks could survive a Japan-style lost decade when the locus of the economy shifts from consumption to production.

In a different way of thinking, it is a good thing that Mr Buffett writes his letters the way he does now. Two decades from now, economists and students of finance may ponder the madness of our times that made a man like him the foremost investing genius in the world.

It isn't just the euro. Europe's democracy itself is at stake

Greece illustrates the danger of allowing rating agencies, despite their abysmal record, to lord it over the political terrain

Amartya Sen

Europe has led the world in the practice of democracy. It is therefore worrying that the dangers to democratic governance today, coming through the back door of financial priority, are not receiving the attention they should. There are profound issues to be faced about how Europe's democratic governance could be undermined by the hugely heightened role of financial institutions and rating agencies, which now lord it freely over parts of Europe's political terrain.

Two distinct issues need to be separated. The first concerns the place of democratic priorities, including what Walter Bagehot and John Stuart Mill saw as the need for "governance by discussion". Suppose we accept that the powerful financial bosses have a realistic understanding of what needs to be done. This would strengthen the case for paying attention to their voices in a democratic dialogue. But that is not the same thing as allowing the international financial institutions and rating agencies the unilateral power to command democratically elected governments.

Second, it is quite hard to see that the sacrifices that the financial commanders have been demanding from precarious countries would deliver the ultimate viability of these countries and guarantee the continuation of the euro within an unreformed pattern of financial amalgamation and an unchanged membership of the euro club. The diagnosis of economic problems by rating agencies is not the voice of verity that they pretend. It is worth remembering that the record of rating agencies in certifying financial and business institutions preceding the 2008 economic crisis was so abysmal that the US Congress seriously debated whether they should be prosecuted.

Since much of Europe is now engaged in achieving quick reduction of public deficits through drastic reduction of public expenditure, it is crucial to scrutinise realistically what the likely impact of the chosen policies may be, both on people and the generating of public revenue through economic growth. The high morals of "sacrifice" do, of course, have an intoxicating effect. This is the philosophy of the "right" corset: "If madam is at all comfortable in it, then madam certainly needs a smaller size." However, if the demands of financial appropriateness are linked too mechanically to immediate cuts, the result could be the killing of the goose that lays the golden egg of economic growth.

This concern applies to a number of countries, from Britain to Greece. The commonality of the "blood, sweat and tears" strategy of deficit reduction gives some apparent plausibility to what is being imposed on more precarious countries like Greece or Portugal. It also makes it harder to have a united political voice in Europe that can stand up to the panic generated in the financial markets.

In addition to a bigger political vision, there is a need for clearer economic thinking. The tendency to ignore the importance of economic growth in generating public revenue should be a major item for scrutiny. The strong connection between growth and public revenue has been observed in many countries, from China and India to the US and Brazil.

There are lessons from history here, too. The big public debts of many countries when the second world war ended caused huge anxieties, but the burden diminished rapidly thanks to fast economic growth. Similarly, the huge deficits that President Clinton faced when he came to office in 1992 melted away during his presidency, greatly aided by speedy economic growth.

The fear of a threat to democracy does not, of course, apply to Britain, since these policies have been chosen by a government empowered by democratic elections. Even though the unfolding of a strategy that was not revealed at the time of election can be a reason for some pause, this is the kind of freedom that a democratic system does allow the electorally victorious. But that does not eliminate the need for more public discussion, even in Britain. There is also a need to recognise how the self-chosen restrictive policies in Britain seem to give plausibility to the even more drastic policies being imposed on Greece.

How did some of the euro countries get into this mess? The oddity of going for a united currency without more political and economic integration has certainly played a part, even after taking note of financial transgressions that have undoubtedly been committed in the past by countries such as Greece or Portugal (and even after noting Mario Monti's important point that a culture of "excessive deference" in the EU has allowed these transgressions to go unchecked). It is to the huge credit of the Greek government – George Papandreou, the prime minister, in particular – that it is doing what it can despite political resistance, but the pained willingness of Athens to comply does not eliminate the European need to examine the wisdom of the requirements – and the timing – being imposed on Greece.

It is no consolation for me to recollect that I was firmly opposed to the euro, despite being very strongly in favour of European unity. My worry about the euro was partly connected with each country giving up the freedom of monetary policy and of exchange rate adjustments, which have greatly helped countries in difficulty in the past, and prevented the necessity of massive destabilisation of human lives in frantic efforts to stabilise the financial markets. That monetary freedom could be given up when there is also political and fiscal integration (as the states in the US have), but the halfway house of the eurozone has been a recipe for disaster. The wonderful political idea of a united democratic Europe has been made to incorporate a precarious programme of incoherent financial amalgamation.

Rearranging the eurozone now would have many problems, but difficult issues have to be intelligently discussed, rather than allowing Europe to drift in financial winds fed by narrow-minded thinking with a terrible track record. The process has to begin with some immediate restraining of the unopposed power of rating agencies to issue unilateral commands. These agencies are hard to discipline despite their abysmal record, but a well-reflected voice of legitimate governments can make a big difference to financial confidence while solutions are worked out, especially if the international financial institutions lend their support. Stopping the marginalisation of the democratic tradition of Europe has an urgency that is hard to exaggerate. European democracy is important for Europe – and for the world.

Exchange rate movements as explained by dealers

 By Tiffany Hutcheson

1 Introduction

Theoretically, the value of a currency is determined by the economic fundamentals of its country, such as interest rates, inflation rates and national income. These fundamentals have an effect on trade and capital flows and hence the demand and supply of the currency. However, there have been many well-known episodes when real exchange rates have moved contrary to these fundamentals for lengthy periods of time (Krugman, 1989). Attempts using empirical models to test economic fundamentals as a basis for predicting exchange rate movements have not been very successful especially over the short run (Taylor, 1995). Furthermore, market practitioners have successfully developed and implemented profitable trading strategies, which do not rely on economic fundamentals. One reason for the poor performance of trading activities based on fundamental analysis could be the behaviour of practitioners trading in the foreign exchange market (Krugman, 1989). For example, some practitioners may trade tactically in a way that forces an exchange rate to move away from its fundamental value. These practitioners would then establish a currency position that becomes profitable once general market trading moves the exchange rate back towards its true value (Rankin, 1999).

To gather information on the factors influencing traders, dealers in the Australian foreign exchange market were asked to complete a questionnaire survey. Their responses can be used to gauge the degree to which economic fundamentals influence the trading behaviour of dealers and hence exchange rates. As the majority of currency trading occurs through dealers, they are an ideal group to survey (Carew and Slayter, 1994). In order for their trading to be profitable they need to pay attention to any factor or event they consider will influence exchange rates. Consequently their responses can be used to obtain information on the relative importance dealers place on various factors considered to influence exchange rates. This information will contribute to the continuing debate on exchange rate determination. It may identify areas other than those previously studied, such as purchasing power parity, which could be researched in order to provide additional explanations for exchange rate movements.

The survey also included questions on the market's trading environment, such as the use of electronic broking, bid-ask spread size and the degree of competition in the market. The dealers' responses to these questions were analysed in an earlier paper (Hutcheson, 2001).

The paper is organised as follows. The preparation of the survey questions and the collection of the survey data are discussed in part two. The impact of changing economic fundamentals on exchange rates is investigated in part three while the influence of non-fundamental factors, impact of economic announcements and predictability of exchange rate movements are analysed in parts four, five and six respectively. Part seven contains some concluding observations about the survey responses.

2 The Survey Data

Each of the institutions licensed by the Reserve Bank of Australia, as at 12th July 1999, to deal in foreign exchange received a copy of the survey. A high response rate was achieved with 39 of the 59 surveys mailed out being completed and returned (1). Consequently, the survey responses should be representative of the views of the majority of dealers trading in the market. As explained in an earlier paper on this survey, most of the survey respondents held senior positions in the foreign exchange section of their institution's treasury department (Hutcheson, 2001). The comprehensive knowledge and market experience of these respondents should ensure the survey responses are a fairly accurate description of events in the market.

Survey data has been used in the past to obtain feedback from foreign exchange dealers (2). Some of the questions used in this survey are based on questions included in surveys undertaken by Cheung, Chinn and Marsh (1999), Cheung and Wong (2000) and Cheung and Chinn (2001). However, the questions are asked in a different way to the other surveys. Consequently, it is difficult to directly compare the responses to all the similar questions across the surveys.

3 Fundamental Movements in Exchange Rate

Market participants known as fundamental analysts adopt the notion that exchange rate movements are determined by the economic fundamentals of the countries represented by the exchange rate. They argue that the market regards a currency, as being under or over valued if it does not reflect these fundamentals thus creating a profitable arbitrage opportunity. In a floating exchange rate regime, where central banks do not intervene, arbitrageurs would buy undervalued currencies and sell overvalued currencies. This trading would force the currency's value to move quickly back towards its true value (Neely, 1997). According to fundamentalists if all currently available information on economic fundamentals is correctly priced into an exchange rate it will only change when new information becomes available.

Regrettably daily and intra-day exchange rate movements are not well explained by fundamental analysis (Singleton, 1987). In fact there have been times when it has appeared as though dealers have simply disregarded economic fundamentals and are merely overreacting to news and rumours (Shleifer and Summers, 1990). As shown in table 1 the majority of respondents believe that intra-day exchange rate movements do not reflect changes in the fundamental value of an exchange rate. They feel that changing fundamental values are reflected a lot more in the movements that occur within a period of six months or greater. These responses reinforce the finding from other surveys that fundamental analysis became more important as the time horizon increased (Taylor and Allen, 1992; Cheung, Chinn and Marsh, 1999; Cheung and Wong, 2000; Cheung and Chinn, 2001).

4 Non-Fundamental Movements in Exchange Rate

The respondents indicate in Table 2 that excessive speculation and manipulation by hedge funds are the main factors preventing exchange rates from reflecting their fundamental value. Excessive intervention by central banks was the next most heavily supported factor while views taken by major trading banks and slowness of dealers to respond did not receive as much support. Whilst speculation has for some time been seen as a force that can potentially destabilise exchange rate movements, only in recent years have hedge funds been one of the factors held responsible for unpredicted swings in exchange rates.

Cheung and Wong's (2000) survey on dealers trading in Hong Kong, Tokyo and Singapore and Cheung and Chinn's (2001) survey on dealers trading in the United States also found that excessive speculation and hedge fund manipulation were regarded to be the major forces behind exchange rate movements.

4.1 Speculation

It has been argued that speculative forces can destabilise currencies and prevent them from reflecting a country's economic fundamentals (Neely, 1997). However, as shown in Table 3, the survey respondents do not unanimously support speculation as a destabilising force with 55.6% indicating that speculation mainly moves exchange rates towards their fundamental value while 44.4% indicate that it moves them away. This is consistent with the finding by Cheung and Wong (2000) for the Hong Kong, Tokyo and Singapore markets. On the other hand 70.67% of the respondents to Cheung and Chinn's (2001) survey of United States dealers considered speculation to be a force that moved exchange rates in the direction of their fundamental values.

The stabilising nature of speculation arises because speculators buy currencies whose value they expect to increase and sell currencies whose value they expect to decrease. When a currency's value moves in the expected direction the speculator will reverse their currency position and profit. As speculators reverse buying positions when exchange rates are increasing and reverse selling positions when exchange rates are decreasing, you would expect their trading to offset large upward and downward pressures on the value of a currency. However, there have been several speculative episodes since currencies began to be floated in the 1970s when excessive speculation has been blamed for driving exchange rates away from their true values. During these episodes exchange rates increased or decreased by more than was supported by economic fundamentals (Krugman, 1989). In particular the exchange rate movements did not support the relationships between exchange rates and changing relative inflation rates and interest rates between countries as explained by purchasing power parity and uncovered interest parity respectively. In other words it was the speculative trading that was causing the exchange rate to move rather than changing market fundamentals. Consequently, when speculators eventually reversed their position it was some time before exchange rates moved back towards their true value. Particularly if dealers who did not normally speculate started to imitate the trading behavior of speculators, a phenomenon known as herding behavior, without regard to whether or not their behavior is supported by economic fundamentals (Banerjee, 1992). It would take these dealers longer to reverse their positions than the large speculators and so exchange rates would continue to be driven away from their true value.

Excessive speculation has been one of several trading strategies adopted by a recently developed type of investment vehicle known as hedge funds. Hedge funds are typically made up of a group of wealthy investors who employ a manager to achieve the maximum return in particular asset classes. As managers are generously rewarded for their achievements, they can choose to adopt aggressive trading strategies (Chicago Mercantile Exchange, 1995). In foreign exchange markets hedge funds have been known to gradually build up very large positions in particular currencies and then reverse these positions rapidly. If their reversal generates excessive exchange rate movements they are able to earn large profits. By building up the positions gradually their impact on exchange rates is only really felt when they reverse their positions. However, only a small number of hedge funds are large enough to create market positions sizeable enough to generate such movements (Reserve Bank of Australia, 1999).

The survey respondents would have recently experienced the destabilising impact of hedge funds on the Australian dollar in mid 1998. Between December 1997 and March 1998 hedge funds were said to have built up large short positions in the Australian dollar using borrowed funds (Rankin, 1999). During this period the Australian dollar was already experiencing a downward trend following the unfavorable impact of the Asian crisis on Australia's trade and capital flows. Consequently, the effect of hedge funds selling the Australian dollar went largely unnoticed. However, as the Australian dollar approached US60 cents, hedge funds began to sell more aggressively and generated uncertainty among other currency traders about what exchange rate the Australian dollar should trade at (Rankin, 1999). Significant Reserve Bank intervention was required in early June 1998 to stop this aggressive selling from continuing (Reserve Bank Bulletin, 1998).

While the respondents do not unanimously support speculation as a stabilising force, most of them felt it increased exchange rate volatility and improved market efficiency and liquidity (see Table 3). The increased volatility can be partly explained by speculators adopting trading strategies differing from those of other market participants. That is they could be buying or selling currencies at a time when other market participants are trading in the opposite direction or not trading very actively. The ability for speculation to improve market efficiency can be accounted for by the tendency for speculators to commence trading when they perceive that current and expected market fundamentals have not been correctly priced into the existing exchange rates (Blundall-Wignall et al., 1993). They will then trade in a manner that forces a currency's value to change until it reaches its true value. This increase in efficiency could also be accompanied by increased market liquidity as previously inactive dealers and dealers who normally trade for other reasons will enter the market to profit from the impact of speculative trading on the exchange rate.

4.2 Intervention by the Reserve Bank

Central banks intervene in foreign exchange markets if they consider volatility to be excessive or currencies to be under or overvalued. In Australia the timing and size of the intervention undertaken by the Reserve Bank has varied across several periods since the Australian dollar was floated in December 1983 (Andrew and Broadbent, 1994). This variation has been due to a wide range of factors such as the severity of exchange rate volatility being experienced and how the intervention will affect other government policies. However, whatever the reason for the intervention most of the respondents feel that the Reserve Bank normally intervenes at the appropriate moment with only 14.3% feeling that its timing has been inappropriate (see Table 4). In recent years the Reserve Bank has seen the need to intervene several times. However, prior to 1997 the Reserve Bank had not intervened since November 1993.

72.7% of the respondents feel that Reserve Bank intervention has been successful in moving exchange rates towards their fundamental values. In fact, 76.55% of the respondents believe that Reserve Bank intervention achieves its goals. These responses support a study undertaken by Andrew and Broadbent (1994) on the effectiveness of Reserve Bank intervention. They argue that intervention will be successful if the Reserve Bank makes a profit from supporting a depreciating Australian dollar by buying at low exchange rate levels and an appreciating Australian dollar by selling at high exchange rates. Their study found that the Reserve Bank's foreign exchange operations had been profitable over most of the periods when intervention was taking place. While the Reserve Bank's trading on behalf of its clients, principally the Commonwealth Government, may have generated some of this profit, the continued finding of profitability over long periods does lend some support for judging intervention to be successful.

The respondents are equally divided on the impact of Reserve Bank intervention on volatility with 50% feeling it decreases volatility and 50% feeling it increases volatility. This appears to be contradictory to the notion that successful intervention should be stabilising. However, volatility is more likely to decrease over the long term, as successful intervention begins to calm down market behavior (Andrew and Broadbent, 1994). On the other hand intra-day volatility would increase when dealers did not correctly anticipate the intervention undertaken by the Reserve Bank, as they would now need to trade out of their current market positions.

5 Impact of Economic Announcements

Whilst the survey respondents maintain that changing economic fundamentals mainly have an impact on long-term exchange rate movements. Unexpected economic announcements made by governments can influence intra-day exchange rate movements. When determining a currency's value market participants will take into consideration the existing and expected economic fundamentals of the currency's country. So when government announcements of the actual fundamentals differ from market expectations, dealers will trade in a way that causes exchange rates to change, if dealers do not react before or at the same time as other dealers any profitable opportunity that exists will be traded away. Several studies using intra-day data have concluded that new economic announcements take only a few minutes to have an impact (Almeida et al., 1998; Kim, 1998). Table 5 reveals that dealers tend to react within less than a minute when announcements from the major developed countries on domestic inflation, unemployment, trade deficit, current account, interest rates, retail sales and gross domestic product differ from what was expected.

Several respondents claimed that in Australia the Australian dollar/United States dollar spot market reacted instantaneously to announcements by the Australian government whilst the reaction time in other spot market currency pairings was more delayed. The market also did not react as quickly to announcements made by countries other than Australia. This may be partly because the overseas announcements, such as announcements from the United States of America, are made while Australian financial markets, other than the market for foreign exchange, are closed. Consequently, foreign exchange dealers may not fully adjust their trading position until they see the response to the announcements from other Australian financial markets when they open the following day (Kim, 1998). For example, dealers may wait to see how the domestic market for interest rate securities responds to changes in overseas interest rates.

Respondents are asked to select the economic announcement from Australia and the United States of America that they consider has the biggest impact on the Australian foreign exchange market. Table 6 shows that five years ago respondents regarded interest rate announcements made by the Reserve Bank of Australia had the biggest impact followed by announcements on the current account, inflation and then trade balance. Today interest rate announcements still have the biggest impact but inflation and unemployment and then the current account and trade deficit now follow it. The strong support for interest rates announcements is expected as the direction and magnitude of international capital flows is affected by changes to relative interest rates between countries. A reason for dealers providing greater support for inflation announcements today than they did five years ago could be due to their growing concern about the ease in which the direction of international capital flows can change. The sudden capital reversals experienced by several Asian countries in the late 1990s made dealers aware of the speed in which the direction of these flows can change. As the Reserve Bank of Australia will place upward pressure on interest rates when inflation increases

above a target range, changing inflation can be seen as a factor influencing capital flows (Reserve Bank of Australia, 1996). Consequently, dealers expect international capital flows will be fairly responsive to announcements of higher inflation. There is still a close link between the current account and trade balance and the Australian dollar, as the majority of Australian exports are commodities priced in foreign currencies (Gruen and Kortian, 1996). Consequently, changes to world commodity prices affect export revenue and hence exchange rates.

Of the announcements covering economic conditions in the United States, the announcements that have the biggest impact on the Australian foreign exchange market today as well as five years ago are those for interest rates and employment. Current account and trade deficit announcements from the United States have very little impact, as they are not seen to be strong indicators of economic and financial conditions in the United States.

6 Predictability

The ability to successfully predict exchange rate movements has been questioned by both academics and dealers. In Table 7 the respondents give very little support for exchange rate movements being either always predictable or never being predictable. The majority of respondents felt that if anything they were more likely to be sometimes predictable. They give slightly more support for intra-day exchange rate movements being sometimes predictable than they do for periods of less than six months and periods longer than six months.

Although the respondents do not regard exchange rate movements as being very predictable, they do believe that several factors can be identified as having a major influence on exchange rates depending on the time horizon in question. In Table 8 respondents maintain that intra-day exchange rate movements are mainly determined by order placements followed by over-reaction to news, speculative forces, bandwagon effects and technical trading. The confidential nature of inter-dealer trades makes it very difficult to obtain data on the volume and price of individual trades. Consequently, the disclosure by respondents that order placements have a major influence on intra-day exchange rate movements indicates that studies of order flows should be able to reveal information on trading behavior.

However, as the time horizon increases the respondents indicate that economic fundamentals have a growing impact on exchange rate movements while the other factors become less significant, particularly over periods greater than six months. Order placements and over-reaction to news only seem to have an impact on intra-day exchange rate movements. Speculative forces and bandwagon effects, where dealers adopt the trading trends of other dealers, have the same degree of impact intra-day and over the medium run. Technical trading, which involves historical exchange rates being used to forecast future trends in exchange rate movements, has its greatest influence on medium run exchange rate movements. However, unlike economic fundamentals, technical trading has little impact on long-run exchange rate movements.

7 Conclusion

This paper analyses the responses provided by Australian foreign exchange dealers to a questionnaire survey on the factors influencing exchange rate movements and hence trading behavior. Dealers will have experienced periods when exchange rates movements were regarded as being normal as well as circumstances deemed to be irregular. Consequently, their responses to the survey questions should be able to provide information on the factors generating movements in exchange rates. While the dealers do differ in their responses to several of the survey questions, a majority response was recorded for most of the questions.

The survey respondents do agree with the theoretical argument that exchange rate movements can be explained by changing economic fundamentals. However, they believe this explanation holds mainly over the longer term. Although when announcements of Australian economic fundamentals are different from what the market expected, dealers are seen to react within less than a minute to correctly price the anomaly into current exchange rates. The economic announcement having the biggest impact both today and five years ago is interest rates.

Speculative behaviour is regarded to be the main factor that prevents exchange rates from reflecting their fundamental value. However, there was no unanimity among the respondents on whether or not speculation was a stabilising force. In fact speculation was seen to both increase exchange rate volatility and improve market efficiency. Excessive intervention by central banks also received considerable support as a factor behind non-fundamental exchange rate movements. Intervention by the Reserve Bank of Australia tends to successfully move exchange rates towards their fundamental value and is conducted at the most appropriate time, according to most respondents.

The respondents did not feel that speculative forces fully explained intra-day exchange rate movements. Factors considered to have a greater influence on moment-to-moment movements in exchange rates were order placements by clients and overreaction of market participants to events. Technical trading was considered to make an impression on medium term exchange movements.

Whilst this survey has been able to identify factors respondents believe influence exchange rate movements, it also found that most of the respondents do not feel that exchange rates can be accurately predicted. In fact they see exchange rate movements as being only sometimes predictable over all time horizons.