The New 'Bubble' in Foreign Exchange Markets

Foreign exchange markets, the so-called FX markets, seem to be going through a dangerous euphoria. According to the most recent analyses by the main international economic institutes, among them the Bank for International Settlements, in April 2013, the daily total operations of these markets was equivalent to $5.3 trillion, with a 35 percent increase from 2010 levels.

We need a basis for comparison with the actual economy in order to better understand such extraordinary measurements. In 2013, the annual trade of the goods of the member countries of the World Trade Organization, which would be the whole planet, amounted to $17.3 trillion. The difference is enormous. Naturally, exchange markets play a relevant and irreplaceable role in international trade, and for a whole series of financial operations that are now linked. Commercial movements and international payments go hand in hand with currency exchanges and contract guarantees and insurances.

But in fact, these are only a tiny fraction as compared to the operations that amount to $5.3 trillion every day. In other words, the greater majority of operations related to exchange markets relates to speculative financial instruments. These financial activities are an end in and of themselves: First of all, they are over-the-counter derivatives in all their possible forms.

Regardless of this, many of those who sing the praises of “the creative unscrupulousness of finance” see in the “explosive growth” of the exchange markets the positive effects of the alleged ability of markets to regulate themselves, following the changes and rules that were introduced on both sides of the Atlantic after the financial crisis. Rather, the expansion of this bubble would be the effect of a series of recent international events. First of all would be the decision of the Bank of Japan to pursue the Federal Reserve’s “accommodating monetary policy” regarding the introduction of greater liquidity, which registered a noteworthy increase in yen operations.

Second is the widespread willingness to diversify investments while looking for the greatest opportunities — even if they are risky — such as the stocks and bonds issued in the currencies of emerging economies. In addition, there has been a dizzying increase in operations carried out by financial institutions that differ from traditional commercial banks, which used to manage almost the entirety of the currency market. We are talking about the so-called “small” banks, which are not subject to the same regulations as the bigger ones, as well as hedge funds. These new protagonists in currency markets are doing the lion’s share, so much so that since 2010, their operations have increased by 48 percent to $2.8 trillion per day. That is more than half the daily total of what we mentioned above.

Last, even small investors participate by proxy in speculative activities, thanks to new trading techniques based on algorithms that make it possible for computers to calculate innumerable operations on the slightest value shifts in milliseconds.

If you notice, since 2010, the dollar has improved its role as the dominant currency exchanged on international markets, while the euro’s market share has declined. While small banks and hedge funds move approximately half of the daily volume, the 10 major international banks control the rest, among which Deutsche Bank stands out tin first place with a 15 percent market share. Then, there are four American banks — with Citibank leading — with 27 percent, followed by three British banks that control 23 percent, and two Swiss banks with 14 percent. For Deutsche Bank, this is additional proof of its dangerous record as the number one OTC derivatives bank.

As we can deduce from what has been shown, the currency market is a market that is predisposed to great manipulation and is a true speculation hotbed. Besides the memos from investigations carried out on the fraud related to the Libor interest rate, for some time, there have been inquiries in different countries on possible manipulations of the methods used to stabilize the baseline FX interest rates. Is it really in the European Union’s interest to allow the euro to participate in such games? Or would it be more favorable to push for maximum transparency in exchange markets and beyond?