Wednesday, October 20, 2004
The global money go-round
Posted by David Smith at 08:36 PM
Category: David Smith' s magazine articles

A feature I wrote for non-economists for The Geographer magazine

Every day, thanks to tens of thousands of mouse-clicks in London, New York, Tokyo, Singapore or Sydney – or as many shouted telephone instructions – tens of billions of pounds, dollars, yen and euros move around the borderless world that is the global financial system. What is the effect of this vast flow of money?

Daily turnover in the world’s currency markets is $1,210 billion (£670 billion). That, leaving aside weekends and public holidays when the markets are closed, is roughly $302,500 billion (£168,000 billion) annually.

These are big numbers. To put them in perspective, the UK’s annual gross domestic product – the combined value of all we produce, or spend, or earn – was £1,100 billion in 2003.

That is not all. The fastest growing financial market sector is so-called derivatives trading. Derivatives sound more complicated than they are – they are merely financial instruments derived from a basic financial instrument. The most common derivatives are futures – instruments that are based around a transaction that will occur at some future date. Currency futures, for example, are based around the notional purchase or sale of a currency at some defined date in the future. Trading in derivatives globally was $600 billion (£330 billion) a day at the latest estimate, and is rising rapidly.

The size and the power of global financial flows are not in doubt. On September 16 1992, “Black” Wednesday, when the UK government was trying to keep the pound within the European exchange rate mechanism (ERM), the euro’s forerunner, the authorities were overwhelmed by the markets. The speculators amassed enough funds aimed at driving the pound down to make Britain’s entire foreign exchange reserves look puny. The pound was forced out.

Or, to take a more recent example, a few months ago, the dollar came under heavy selling pressure because of concerns about the American economy and Iraq. Asian central banks, particularly China and Japan, were reluctant to see their currencies rise against the dollar.

They were more successful than the Bank of England in 1992 but only as a result of buying tens of billions of dollars. More importantly, they diverted the selling pressure on the dollar to Europe, so that the euro rather than Asian currencies rose strongly.

What drives these flows of international capital between countries and continents? It is not international trade. It used to be the case that the only reason for anybody to want to change currencies was for exporting and importing purposes. This is not so any more. A week’s trading on the currency markets is equivalent to a year’s world trade. Even adding tourism does not begin to square the circle.

Capital is driven around the world by two factors – risk and return. International investors are looking for the best return, and do not mind where they get it. Return can mean chasing the highest interest rate or the best performing stock market. But return has to set against risk. There may be a reason why a developing country (an emerging market to investors) has 30% or 40% interest rates, and that is because its currency and its economy are wobbly.

In seeking the best return, investors do not want to be left holding the baby of a collapsing currency. In times of international tension, or when concerns about inflation re-emerge, investors seek “safe haven” currencies such as the Swiss franc, or safe-haven assets such as gold.

Is all this money flowing around the world healthy? James Tobin, the late American Nobel prize-winning economist, proposed a “Tobin tax” on currency trading to curb speculative buying and selling of currencies. There is no doubt some such trading is destabilising.

The problem is in distinguishing between the speculative and the beneficial. Developing countries cannot generate the savings they need to invest for the future. Inward investment, either direct (new factories built by multinationals) or indirect – foreign money that enables locals to invest is needed. This year, according to the Institute of International Finance in Washington, long-term capital flows to developing countries will reach $225 billion (£125 billion), their highest since 1997. But emerging economies can find themselves on the wrong side of the vagaries of short-term capital. In the 1990s, international investors favoured the so-called mini-tiger economies of Asia, like Thailand, Taiwan, South Korea and the Philippines. There were long-term capital flows into these countries but also plenty of short-term speculative capital, chasing stock market returns. When such capital suddenly took flight, on fears that economic risks had increased, it created the problem investors had feared – the Asian financial crisis of 1997-8.

It is not just developing countries that are in need of foreign capital. America has a trade gap, a current account deficit, of $500 billion (£280 billion) and needs foreign capital inflows to fund it. One of the big risks to the global economy is the over-reliance of the United States on foreign capital and the danger that a sudden loss of international appetite for American assets could lead to a dollar collapse.

From The Geographer, September 2004

Comments

the ecomomics scied is the very information

Posted by: javed ali at January 11, 2005 06:33 AM