Foreign Exchange

Rudi Weisweiller

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351722889
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Originally published in 1972. This book covers the broader aspects of foreign exchange, for businessmen, to remove a hazardous gap in executive knowledge. The language is non-technical and the author gives an insight into the workings of the international currency markets which will enable business-men to operate more easily and be more profitable in this field.

Contents

1. Preface
2. 1 Why Foreign Exchange?
3. 2 How the Foreign Exchange Market Works
4. 3 Five Choices
5. 4 Money Across Frontiers
6. 5 Currency Freedom
7. 6 Overseas Investment
8. 7 Eurodollars
9. 8 For or Against Speculators
10. 9 Gold
11. 10 Liquidity, Reserves, Special Drawing Rights
12. 11 The Causes of Currency Crises and their Cure
13. 12 Bretton Woods or Chaos
14. 13 The Future of the Sterling Area and the Common Market Currency
15. Index

Preface

This is not a textbook in the usual sense, but a series of, I hope, readable essays. It is intended for the sophisticated businessman or manager in industry as a general introduction to the whole complex field of foreign exchange. It does not claim to deal with the problems which mainly concern the full-time professional in the foreign exchange market; it aims to ease the first steps towards a fuller understanding of the situations which arise for international trade and investment because different countries use different currencies. The events and arguments in recent currency crises have therefore not been described in detail.

Apart from experience, my main teachers were Emil Kuster of New York and Walter Fankhauser of Zurich, to whose wise guidance and instruction nearly twenty years ago I owe so much.

RUDI WEISWEILLER

Chapter 1

Why Foreign Exchange?

EXAMPLE

When one goes into a shop and buys something which was made abroad, whether it is a Swiss watch, some French wine, a German motor-car or a Dutch cheese, one causes a foreign exchange deal to take place.

Let us use Scotch whisky drunk in the United States as our example. There are two ways in which the businessman who sells it in the USA can pay the distiller of the whisky who lives in Scotland. He may send us dollars to Scotland which, however, the supplier cannot normally spend in his own country and therefore would have to exchange for British pounds; he has to ask a bank to change the dollars into pounds. In this case, the Scottish supplier and his banker do a foreign exchange transaction together, each taking one kind of national money and giving the other.

There is another way of paying. Knowing that dollars are not legal tender in Scotland and that, therefore, when received from the American buyer in payment for whisky they would have to be exchanged by him at his bank, the Scottish supplier may decide to avoid this effort with its attendant delay and expenses. He may ask the American businessman to pay in British pounds; in other words he invoices the whisky to the buyer in British currency. If this is the case, the buyer has to go to his bank in the United States, change some us dollars into British pounds and then send these to Scotland.

In this instance, the foreign exchange deal has been done in the United States, between the buyer and his bank.

BASIC PRINCIPLES

Whether the foreign exchange deal is done in the United States or Great Britain does not affect the fundamental nature of the transaction. Indeed, certain basic conclusions about foreign exchange can be drawn from this or any similar example:

1. If a business transaction involving money has been concluded between residents of different currency areas, it necessarily involves a foreign exchange deal. This simple statement explains the existence of foreign exchange markets with their expensive machinery and highly paid dealers. It explains the unavoidable preoccupation of those concerned with economic problems, whether academics or politicians, with the international section of economic activity and its barometer, the balance of payments. It shows that international trade leads inevitably to foreign exchange, and that foreign exchange leads frequently to problems for nations, companies and individuals. It explains why this book is written.

2. A foreign exchange deal is an exchanging of one currency or national money for another. It is like any other business deal in that one thing is exchanged for another, but it differs in that, whereas usually we exchange goods for money or money for goods, in foreign exchange one national money is exchanged for another.

This latter remark leads us inevitably to a further point which is not without significance. If the relationship between goods and money in ordinary business transactions is expressed by the price, then this is equally true in foreign exchange: the exchange rate is the price of the one currency expressed in terms of the other. It expresses a price relationship.

There is, however, a difference in practice between exchange rates and ordinary prices which is all too rarely recognized and heeded. When an ordinary price moves up or down, one is usually entitled to look for the reason towards a change in the demand for, or the supply of, the goods. For example, when peas get more expensive, this tends to be due to a shortage of supply for seasonal or special reasons, or to an increase in demand because of a change in fashion or because alternative foodstuffs have disappeared or become more expensive. One does not ascribe the change in the price of ordinary goods to a lessening in the value of money, unless one is either studying a large number of price increases which appear to coincide and also to lack separate explanations connected with demand and supply, or comparing prices over a period of years or even decades. Only in such circumstances does it make sense to say that fares have gone up from the equivalent of 2p to 15p in twenty-two years, not because transport is harder to organize or more efficient, but because money has been greatly reduced in value. It is still necessary to decide to what extent the change in fare is due to the reduction in the purchasing power of the pound, and to what extent a change in the demand-supply situation has altered the real price of the service.

The foreign exchange rate is different, even in the short run. It expresses a relationship between two national monies. It is unrealistic to assume that changes, even over the shortest period, express alterations in the demand for, or supply of, one of these national monies. Whenever an exchange rate moves, this must be due to a change in the value of one or the other currency, or partly of one and partly of the other.

It is very tempting and very wrong to see changes in rates of exchange as reflecting necessarily some alteration in the demand for, and supply of, our own currency, and to rejoice when our own currency appreciates or to plunge into the depths of gloom when its price drops. How often do we in fact look, as we should, at the economy of the country with whose currency we are comparing our own currency in the exchange rate under review? It could be that events in that country explain some or all the change, and that our own currency has not really caused the change in rate. Comparison of the performance of both currencies with a third currency can usually throw useful light on the reasons for a movement in exchange rates, although this can be obscured by a variety of incidental factors which may be hard to isolate or analyse.

3. Foreign exchange deals depend upon international commercial transactions for their existence. Unless people in one currency area buy from people in another currency area (and vice versa, for otherwise the balance of payments of the first area would be in an awful mess), there will be no foreign exchange deals.

Every foreign exchange transaction carried out anywhere in the world is a link in a chain at the ends of which there are two customers who wish to exchange foreign currencies in opposite directions. It does not matter how many links are in a particular chain; sometimes the efficiency of the market is assured by the length of the chain, the multiplicity of professional middlemen or banks. It does, however, matter that at both ends of each chain stand people who are exchanging one currency for another because they themselves have done business with someone abroad. Thus, every exchange deal between two banks in sterling against dollars presupposes an American buying British goods, services, land or investments, and a resident of the United Kingdom buying American goods, services, land or investments. If one of the currencies is bought by someone in a third country, this establishes no exception to the rule, as he in turn only wishes to hold such currency insofar as he or somebody else can eventually buy goods, services, land or investments in the country whose currency he has bought.

WHOM THE MARKET SERVES

The mention of goods, services, land and investments brings us to a further analysis of the elementary uses of the foreign exchange market. There are four groups of reasons which bring people into the foreign exchange market as buyers or sellers of foreign currencies.

The first group of reasons is covered by the previous reference to goods, services, land and investments. It can be covered by the term ‘commercial reasons’ and includes such transactions as foreign travel, the purchase of foreign stocks and shares, the sale of a factory to a company in another currency area, commissions or royalties received from abroad, as well as ordinary payments for imports and receipts from exports.

The second group is closely tied to the short-term investment of spare funds in the money market. Investors of such funds sometimes seek higher returns abroad without regard to the risks of a possible change in exchange rates; these investments are then loosely termed ‘hot money’. More often, these funds are moved across frontiers and into another currency only when the exchange risk can be eliminated by a contract for future delivery at the same time as the initial deal is made for immediate delivery. The theory describing the rules for this considerable volume of transactions is known as interest arbitrage and is described in more detail in Chapter 4.

The third reason for entering the foreign exchange market is termed ‘speculation’ : the desire to buy what one does not need, but hopes later to sell at a profit to those who do; or the desire to sell for future delivery what one does not have nor even expects to have, but hopes to buy at a lower price before one has to deliver it. Essentially, to buy a house for oneself to live in at an opportune time and in a place which one deems likely to become more popular, is a good investment; to buy a house at the same time and in the same place merely to enable one to sell at a profit and not to live in, is speculation.

Chapter 8 deals in more detail with this concept and some of the strong opinions people hold about it. There is no doubt, however, that some professional dealers, mostly in respectable banks all over the world, go long or short of foreign currencies in the hope of making profits. Their activity is covered by neither of the previous categories, although it is often carried out in conjunction with deals within them.

Nor is the fourth and last category, however closely tied to the activities of traders, investors and money men, one which can be regarded as coming legitimately within the three groups already described. At a later stage, the international monetary system set up at Bretton Woods in 1944 and enshrined in the rules of the International Monetary Fund, will be discussed. Here it suffices to note that the central banks of all countries which belong to the International Monetary Fund, except the United States, are obliged to deal at the so-called ‘intervention points’ for spot delivery. In addition, they are allowed to enter the spot market at all levels between these points and the forward market at any level. Such voluntary intervention by a central bank is usually motivated by one of five reasons:

1. The central bank may be fact-finding, trying by its own action to measure the force of market trends.
2. The central bank may be intent on building up its own currency reserves or those of another country, or on reducing them.
3. The central bank may be wishing to prove that it will resist an attack on its own currency with all the reserve resources at its disposal.
4. The central bank may wish at times of crisis to give the impression, without being seen to help, that its own currency is more generally wanted than it really is.
5. The central bank may want to keep the exchange rate at a particular level in spite of market trends which, if unchecked, would move it elsewhere.

Whether a central bank intervenes in its own name, through another central bank or through the kind offices of a commercial bank at home or abroad, will depend largely on whi...