Currency Traders: The Fed Has No Clothes! Part 5

04/25/2008 12:00 am EST


Timothy Morge


(Or, in other words: What’s Going To Happen With the US Dollar?)

Let me explain the state of the currency markets in the 1980’s: More than ninety-five percent of all cash currency transactions were made through banks. Brokerage firms did not offer cash FX prices, companies had to deal through banks and cash brokers only dealt with banks and a select few Investment Firms.  The banks controlled the flow of all the cash currency transactions and other than outright position limits and cash FX trading was basically unregulated in the bank arena.

Today, only roughly fifty-five percent of the transactions in the cash FX market go through banks. The rest go through exchanges, FCMs that make markets in cash currencies to retail and institutional customers and through the electronic brokerage service, a brokerage clearinghouse that allows very large net-worth individuals, corporations, banks and investment firms to deal direct. These days, General Motors can sell dollars directly to a large private speculator through EBS. The days when the handful of large banks in the world controlled the cash FX markets and could really influence flows are gone. Banks no longer have the risk tolerance to carry the huge speculative positions we routinely carried in the 1980’s—they have credit risk and mortgage portfolio problems to worry about. Risk has shifted largely to the speculating crowd and the central banks don’t have control of that crowd. For better or worse, control of the cash FX market has shifted from the few to the masses and that has greatly diminished whatever power the central banks had, IF they ever had the power over the cash FX markets traders attribute to them in ‘the good old days’ of cash FX.

The dollar is currently in a very strong down trend. Until that long-term trend changes, the central banks know that buying US dollars against the major currencies is throwing money away. They do not have the reserves or the sheer power to turn these long-term trends in the cash FX market. And in the case of the United States, the Federal Reserve has so many other urgent matters it needs to address, the dollar’s level is not even on the list of policy items worth pondering.

Currency traders shouldn’t spend any time or emotion worrying about whether the central banks are going to stop the dollar’s slide. The truth is quite simple: when the flow of capital out of the United States ends, the slide of the dollar will stop. It’s well known amongst the larger market participants that the countries that had traditionally held the majority of their reserves in US dollars have been diversifying their reserves out of US dollars and into other currencies. China and Japan have sold a huge amount of US Treasury Instruments and then sold the US dollars they received from these sales—many insiders estimate that China now holds less than 1/3 the US assets it held three or four years ago.

With the emergence of several new large economies [Europe, China and India] that are beginning to rival the US in buying power, investors around the world realize that ‘flight to quality’ may not necessarily mean a move into US denominated assets. As little as six months ago, when I mentioned it might soon take three US dollars to buy one euro, people generally felt I was overreacting to a short-term down trend in the dollar. But these days, it’s become clear that the United States is not in the driver’s seat when it comes to determining the level of the dollar, the level of their own interest rates and the capital flows in and out of their own country. The markets will take the currencies where they take them and the central banks, like all other traders, can go with the flow or stand aside—anything else will result in losing positions that eventually will be liquidated.

I wish you all good trading!

By Timothy Morge

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