Currency Strategy A Practitioner s Guide To Currency Investing Hedging And Forecasting Wiley_5

Part Two Regimes and Crises @Team-FLY 5 Exchange Rate Regimes: Fixed or Floating? To most modern-day readers, at least those within the developed markets, the exchange rate norm is and has always been freely floating. All sectors of society have become used to volatile exchange rates and have learned to plan accordingly. Individuals plan vacations when the currencies of their planned vacation destination are perceived as cheap. Businesses seek to hedgetheirtransactionalortranslationalriskaccordingtoacombinationoftheirbusinessneeds andmarketconditions.Politicianshaveamixedrecordwithfloatingexchangerates,frequently viewing exchange rate strength as a sign of national economic virility—and exchange rate weakness consequently as a test of their own administration. Yet, it is not that long ago that such a test would have been inconceivable. Freely floating exchange rates are themselves a relatively recent phenomenon. Indeed, the period since 1973 and the break-up of the Bretton Woods exchange rate system has been the first sustained time in history in which the world’s major currencies have not been pegged to some form or other of commodity. Such a world of freely floating exchange rates, massive private capital flows financing current account deficits and markets dictating government monetary and fiscal policies was completely inconceivable in 1944 when Bretton Woods was created. To recap, under this, member countries pledged to maintain their currencies within narrow bands against the US dollar, while the dollar itself was pegged to gold (at USD35 per ounce). Some degree of flexibility was allowed, but there was never any suggestion—or conception—that governments were not in charge. For 27 years, the Bretton Woods system held in place, helping to provide a foundation for economic growth in the 1950s and 1960s. Then, as the value of the US dollar peg to gold came under ever increasing pressure, the US eventually scrapped its gold peg, trying in the process to create a slightly more flexible exchange rate system under the Smithsonian Agreement. In 1973, the effort to defend this too was exhausted and collapsed under the weight of its own contradictions. Thus, since 1973, we have had for the first time an international monetary system which has for the most part been characterized by freely floating exchange rates among the major industrial countries, free of official intervention or commodity-related pegs, with “the market” taking an increasinglyimportantrole,bothrelativetobefore1973andalsotoofficialgovernmentpolicy. Granted, since then, there have been several attempts, such as the Exchange Rate Mechanism (ERM), to shackle exchange rates within narrow bands. For the most part, such attempts to re-assert government control over the market have given way to some degree of accommodation between the two sides, with freely floating exchange rates allowed but official intervention seen as appropriate at times of extreme volatility or where prices have “overshot” economic fundamentals.Thisaccommodationhasresultedinspecificvictoriesofasortforbothsides.The ERM itself, having barely survived the 1992 crisis, was forced under extraordinary pressure in 1993 to widen its bands to ±15% from ±2.25%. However, since then, member countries have relinquished their national currencies in favour of the Euro, thus eliminating the question of 108 Currency Strategy fixed or floating at the national level. The Euro itself is still however a freely floating currency, as its volatile movements have born testimony. Still, for the most part, the question of having a fixed or floating exchange rate regime has increasingly become a redundancy for the world’s industrial countries, particularly as barriers to trade and capital have been broken down. The US dollar, Euro, yen, sterling and others all float against each other, for the most part without official interference. While there are still occasional bouts of intervention by the central bank, these are nowadays a relative rarity. What has become far more common is that central banks will attempt to guide the market through “verbal intervention”. The extent of the accommodation arrived at by the market and the official community is such that this for the most part works well enough, though to be sure there are times when it is not enough and substantial foreign exchange intervention in the market has to be undertaken. For currency market practitioners in the industrial countries however, such as corporations or institutional investors, the question of the type of exchange rate regime is largely (though perhaps not completely) no longer relevant. National currencies maybindtogethertobecomeregionalcurrencies,butthebottomlineisthattheyarestillfreely floating and not artificially pegged. 5.1 AN EMERGING WORLD This is not the case in the “emerging markets” or “developing countries”. While there has undoubtedly been a gradual trend towards freely floating exchange rates within the emerging markets, whether willingly or otherwise, many still have some form of peg arrangement, depending to some degree upon their state of development. Thus the question of the type of exchange rate system—fixed or floating—remains particularly pertinent for currency market practitioners who are involved in the emerging markets. In order to suggest how currency market practitioners might deal with exchange rate system issues, it might be useful to explain first why these exchange rate systems came about in the wake of the developments of 1973 and how each type works. When—or if—one thinks about the 1970s, it is usually from a political perspective, as a timeofwarandrevoltagainstwar,asatimeofpoliticalandsocialrevolution.Nowadays,many of the protestors of that time are in business. Politically, much has changed. The economic worldhasalsochangedmassively,tosomeextentinlinewithsomeofthesepoliticalshifts.The decline of the Soviet Union coincided with the decline of the socialist attempt at economics. People who were finally able to turn on their television in the Warsaw Pact countries and tune themtoWesternstationsfoundtheyhadbeenliedtoforageneration.Thetriumphofcapitalism was confirmed. From that time, when West and East no longer glared down the barrel of a gun at each other (or more aptly the nose cone of an ICBM), such terms as “market economy” and “globalization” have developed. Just as we now take for granted floating exchange rates, so we also take for granted free trade and capital mobility, yet many of these were the direct result of the end of the Cold War. WiththedeclineoftheSovietUnionandtheendoftheColdWar,emergingmarketcountries have been able to move away from being mere chess pieces in a bi-polar world. Crucially, the breaking down of barriers to trade and capital, which began in the late 1980s and accelerated inthe1990s,hasallowedthemtoparticipatetoanincreasingdegreeintheglobaleconomy.As the role of the emerging markets has increased within the global economy, and perhaps more specifically within global financial markets, so the pressure has grown on them over time to ... - tailieumienphi.vn