Currency Volatility, Speculators Instincts with respect to Developed, Emerging and Under Developed Economies

Currency Volatility, Speculators Instincts with respect to Developed, Emerging and Under Developed Economies

There is a general belief all over the world that QE or Quantitative Easing may slowly be withdrawn. This in other means would mean that tapering would soon be announced. When we talk of QE, we mean only the US dollar and tapering means that the dollar printing would be slowly reduced stage by stage. However, to refresh everybody’s memories QE is happening in several other developed countries passing through difficult economic depression. This includes Japan which has its yen printing and so does Euro. There is of course political implication of this as many countries still do not have much idea as to what is happening yet for the moment we here shall talk about the economic angle only.

Now the question here is whether the QE is evil or good? The answer is quite simple and that is it is both an evil and a boon. It is the perspective which we try to look at it and the resulting way that it is being done that makes it either good or bad.

To start with this theory suggests that the QE (US Dollar) will not end any time soon, but may extend into the far future too if there is larger perspective to it in terms of taking responsibilities or challenges.
In sharp contrast if it is only for some temporary adjusting mechanism then tapering is the only way out.  If former is the case then there will be some reduction in bond buying and not a full stop of it. What we all might see is a manipulation on the QE and nothing whatsoever to stop it. In the latter case there will be slow tapering that will end the flood of money in the world currency market. Isn’t this unconventional and absurd? It shouldn’t be so if you were to look at the whole of the world economy in the right perspective. Had it been only for a single country perspective then the whole thing is absurd and unconventional. Yet when the whole world at large is intricately involved the process attains a different status altogether.

What is QE?

To begin with QE is releasing certain quantity of money into the system. Now you may ask which system? If it is the US economic system then there is great danger as sooner or later the financial system will collapse on its own hollowness of not having enough equity or asset backing to support the excess flow of dollar into the market. Here, it will be subjected to the theory of ‘emasculation and escalation of near money instruments’ as I had written earlier.  

Then into which system is the Quantitative Easing being carried out? Of course, into the world economic system and herein lies its obvious stability factor. Both the US bond and the US dollar are at hardly at risk when the same is connected with the world economic system and not the US system alone. It must be borne in mind that the domestic stories of the emerging economies and under developed economies are still there to be written. The actual process of development may vary and could be carried out within a few years or longer according to the policies of the government of these countries. Even in the case of closed economies too the potential to develop within the domestic front is immense and sooner or later they will have to open up. Theirs is, as a matter of fact, raw economic stories yet to be written.  

This also means that the US economic cycle is relatively weak with that of the present world’s economic cycle and more so with that of the future world economic cycle. However, by merging the former with that of the latter the US economic cycle would stand to gain although the world economic cycle would be under pressure.  It would also mean that tapering of the liquidity easing would have to start if the developing or emerging economies show visible signs of low growth or going back to recession. This is because the actual value of dollar in relation to the equity base support received from emerging economies would start to fall. The only way for the dollar value to regain strength in relation to global economy is by reducing money printing in such cases or by exerting maximum dollar strength to prop up the sliding economies around the world rather than simply allow asset prices to shoot up. If the QE or tapering mechanism is not properly carried out then valuation of dollar in relation to the world economic cycle would remain extremely stressed.

So the best way for the US dollar to stabilize with adequate equity based support is to hang on to the domestic stories of the emerging and undeveloped markets. This obviously brings about the much needed stability for the US currency and the same is only subject to pressure when tapering is announced. Hence, from the point of view of US there is nothing wrong with hitch riding on other economies when whatever little improvement is noticed in USA is hardly inspiring from an economical point of view. Further there is no need to dismiss the fact that there is an obvious addition to the overall US economy through the newly arising trade relations due to the increased leverage of the dollar as the world’s unofficial reserve currency.

This can be stated in another way and that is the world at the moment is seeing a scenario that is as much a reality as it may ever be. And this if explained economically is that through the influx of dollars into the world’s economic systems, the emerging economies and undeveloped economies are actually purchasing US dollars by providing sealed bonds to the FED. Why is it so? It must be remembered that the major dollar flow has been invested for investments in the emerging economies and is being speculated with that of other currencies.

Hence, for the moment the US dollar will not be under much pressure due to lack of asset or equity backing, and will only be subjected to the theory of emasculation and escalation of near money instruments in relation to the business cycle of the world economy. It is to be noted as earlier stated all these speculations are carried out with biasness to the predominant currency.

Emerging scenario of business cycles

The business cycle of the world economy is far better than the business cycle of US economy and when the latter merges with the world economy with a reserve currency printed unilaterally it exerts a tremendous pressure and influences on the economies around the world. How does this affect the overall position of the world economy with the steady flow of US dollar into the world financial system? It affects greatly the world financial system with uncertainty as to whether the value of dollar will remain stable in the long run or whether it may adversely affect the emerging economies actual asset values. In short, when there is steady increase in the flow of dollar into these countries it will greatly increase the value of select assets through the principle of hedging or call it risk parking on all dollar purchases.

This would inevitably corner the domestic investors in these economies to pause investing or to forego taking risks by purchasing assets whose prices have already been greatly inflated by foreign investors. Contrary to popular perception,   as they say that volatility happens mainly due to the fact that tapering will be announced or not and that the dollar will inch up slowly when the US economy improves, but far from that and this means that the volatility happens due to the fact that there is an imperceptible and intuitive feeling among investors and speculators whether the dollar tries to legitimately achieve the status of world reserve currency visa vis other currencies or not.

Then where is the actual problem? The problem lies in larger than unimaginable financial bubble burst which no one would ever have anticipated and which may begin to unfold. In fact, the human population is already well entrenched in a swelling financial bubble. How is it possible? In order to understand this perplex question it is better to get to know something about currency speculators instinct and speculators nuances in course of trading with foreign currencies.

Speculators instincts

Speculators speculate in currency market to make a windfall profit. They wouldn’t speculate if there is no profit mostly in near terms. If the speculators speculate in currencies by positioning themselves for a long run or long term potential gain, then they are not speculating, but have changed their course to investing. It is to be noted that speculators may or may not be aware of their own instincts while speculating in foreign currencies, but readily pour their efforts to speculate with that basic instinct by ascertaining various scenarios including political, economical, social, business and financial information. The speculators do this intuitively after getting the nuances that each sudden occasion and events may demand from them a motive to reason out a quick profitable move.

From the above we can reason that the speculators all speculate in foreign currencies if the financial environment is liberal enough and the currencies are partially or wholly convertible. If the currency is not convertible then there is no reason why the speculators should take any position as there wouldn’t be any windfall profit. Again, speculators will carry out speculation on a daily basis so as to bring about the much needed liquidity in the currency market as well as make it easy to ascertain the real value of one currency with that of another.

But do all speculators make profits? Surely not, for just as many of them make profits so does as many speculators make losses too. However, this is not important from the point of view as the total acts of the speculators bring about the much needed currency stability in the international market. This means it is not necessary for all intuitive speculation in foreign currency by all individual speculators should end in a profit. It means that the sum of their collective strength from individual speculative efforts, including the reduction of losses from their profits, is much more than the total derived out of each of their individually nuanced or intuitive based speculative position.

The above factor gives the currency market its required stability with speculators speculating on currencies with a larger percentage of them putting their efforts with a definite bias on the strength and weakness of the reserve currency. Here, in this case it will be the US dollar and in all other cases speculation will be carried out, where there is absence of US dollar, with a definite bias on the next full convertible superior currency. A superior currency is one through which most of international transactions and trade can be carried out if not fully.

The reason for this bias while speculating is noteworthy and important as it is seen that all currency speculators would in one way or the other ultimately revert back major part of their income and profits into the full convertible superior currency and not in the other currencies. This biasness will prevail in every foreign exchange transactions unless all other economies are vibrant economically with fully convertible currencies. Again, any currency which is not fully convertible and that is speculated in open international market suffers from the ‘factor of being naturally disadvantaged’.

Governments as Speculators or moderators

Unlike the foreign currency market speculators, the governments of some countries may turn speculators to make some profits either directly or through proxies or otherwise they may turn to regulating the market in one way or the other and therefore simmer or make bitter the volatility that exists in currencies.

In recent times the group of 20 nations had agreed to swap currencies and there have been results although you actually need to settle the swapped currencies some time in the future with interests as agreed upon. This is one arrangement. This is usually resorted to when there is unbridled announcement of tapering by the FED. This cannot be so as the US dollar has not attained the actual status of the world currency and any tapering must be done with prior consultation of all countries. There is a lot of confusion here which actually results in currency volatility and speculators make the best out of it.

The decisions taken by governments and regulators make sure that the domestic currencies caught in the undercurrent volatility remains stable with that of the speculator’s biased foreign currency in terms of fluctuation in value. This may bear fruit or may not and totally depends upon the powerful speculators of the foreign exchange market. It must be noted that these powerful speculators are not just individual or small organization, but are huge multinational giants with trillion dollars in assets, financial giants including banks and huge corporations who have sizeable account and activities in speculation all over the world much more than their real business. As a matter of fact, these corporations make major percentage of their profits through currency speculation and not through their manufactured products which if at all is only a small percentage amount of their balance sheet.

There are tiny countries that speculate through proxies or by themselves in order to reap profits and in the end one sees there is an ever greater churning of financial instruments and currencies backed by even lesser and lesser equity based support for these. This creates a bubble and presently the whole world is sitting on it.

However, unknown to most parts of the world the notion that volatility can be curtailed with regulating mechanism like purchasing and selling off dollars, the fact is that huge volatility with apparent biasness towards a predominant currency can be rocked or burst with sudden infusion of that predominant currency into the international market by a government.  For instance, there is huge volatility of the world reserve currency where a lot of speculators have taken position. Then if all on a sudden there is a sudden dumping of sizeable reserve currency on a single day then financial mayhem will occur. For example if there is hot speculation in the international market and the dollar is rising high in relation to other currencies and if large speculators take up position then a government wanting to tame the rise of the dollar can dump around 30 to 50 billion dollars on a single day without a pre-warning.  This happens because in spite of huge liquid cash with some large speculators they actually put in only a percentage of their cash in speculation and thus wouldn’t be able to square their position in case if a country’s government dumps a large amount of their reserve foreign exchange fund in a single day.  Of course there must be sizeable reserve for a government to do so and this reserve may get build up slowly and steadily as we shall see in the discussion below.

In the above case it is seen that the outcome of such dumping can be immense. In such case the sum of the collective individual nuanced speculative positions of different speculators will be far less than that of the total of each of their individual speculative position after deducting the losses from profits. Therefore, the foreign exchange market will experience huge volatility and total crisis.

Here, in the above instances too the governments may try to regulate volatility of the domestic currency with that of the predominant currency. This will however be dangerous for the international financial market. The precautions which the predominant countries may take are to keep their own financial institutions and large corporations indulging in such large speculation in strict lease through frequent audit and other stringent rules and regulations.

A more complete picture will emerge after studying the 9 stages of speculative attempts of a currency with that of other currencies. Although the speculators tend to exercise their intuitive nuances they may not have the actual reason as to why they are taking such a course.  It is also quite mandatory that speculators must speculate to derive at the right valuations of currencies in all free market systems and they play a very significant role in maintaining the actual market value of the currency. This can be explained with the help of a diagram. It is to be noted that the stages of QE is not the stages when money is realized by FED or any other Central Bank of a country, but the stages of intuitive perception that speculators make when speculating.

1^st Stage of QEs in relation to the other world currencies and speculators instincts

The economy of the predominant currency is strong in the eyes of the speculators. The currency will be traded freely with an overwhelming bias to the predominant currency.

2^nd Stage of QE

The biased currency will still be strong enough and the liquidity easing may make it flexible will not generate any difference as was the case with Stage 1. The speculators will not sense anything and will continue trading with a bias to the predominant currency.

3^rd Stage of QE

The huge liquidity in the world economic system may be slightly disquieting with speculators simply frowning only and still carrying out their speculation with a definite bias towards the predominant currency.

4^th Stage of QE perception

The speculators will begin to doubt the long term viability of the predominant currency and speculators may still think that there will be reversal of this flow sooner or later. Speculation will not be so biased towards the predominant currency.

5^th Stage of Liquidity perception by the speculators

There will be firmer belief among speculators that something else in happening on the screen and that there may be a delay in the reversal of the liquidity into the world economic system.  There will no more any biasness to the predominant currency and some speculators may actually turn investors in equity in other countries other than the country of origin of liquidity. There will be pressure on rating agencies not to downgrade as the predominant currency is invested in these countries and therefore the mathematics do not balance or work out well. This will also be the stage when other countries slowly and steadily increase their stock of the predominant currency with their Central Bank.

6^th Stage

The belief in continued liquidity gains momentum among speculators and their intuitive nuances say that the predominant currency is turning into legalized World Reserve Currency or in the process of being so. Governments of other countries will exercise political and economic options to stem the marginalization of their own domestic currencies with that of the predominant currency. Many countries with very weak currency may undergo a process of intense marginalization coupled with weak economy and the predominant currency will set pace to become the acceptable legal medium in these countries. Weak currencies will slowly give way to the predominant currency as its own dominant currency.

There will be initial advantage to such weak economies especially in relation to imports and this would only be sustained through continued economic reforms. There may be similar liquidity easing by more than one currency and countries and thus creating severe economic delirium.

7^th Stage

This will be as stage of political friction and volatility of currencies and speculators will heavily speculate against all odds without bias due to this period of uncertainty.

8^th Stage

There will be lack of official clarity or international clarity as to the legal status of the predominant currency or currencies. The currency will never be accepted in this form as it being issued by a single country unilaterally or one or two countries in unison. A currency with the approval of the majority members of the UNO will only be accepted. Hence, the stage is set for more speculative activity without any bias whatsoever. This uncertainty may ruin the world economy if no agreement is reached. This will be the stage when governments may dump huge amounts of the predominant currency they are holding as stocks and at the same time accumulating the same currency stealthily and steadily. If no agreement is reached then this will set the stage for the heavy devaluation of the predominant currency with speculators turning their biasness to those of other weaker or prominent currencies.

9^th Stage of liquidity easing in relation to speculator’s perception

The final stage will be for resolution from the political angle only with countries trying or not to reach an agreement.