The Way of the Dollar

CHAPTER ONE

Those who know do not talk. Those who talk do not know.'

LAO –TZU

And those who can, do; those who can't, write? Well writing is some thing I do; and trading is also something I do. And I'm still learning how much I don't know about both. Here's another confession. I see the currencies as the biggest, most fascinating, most profitable and most dangerous casino in existence. No, it's not really a casino. In casinos you cannot win by skill. In currency markets you can. But it is a casino, in practice, for most of the people involved: only they don't put on their own bets. For most participants, the currency gamble they find themselves involved in is an occupational hazard. The European investor who buys Japanese stocks or US bonds; the contractor who bids for a contract in the Middle East; the multinational corporation which borrows in dollars; exporters, importers, shippers, travel agents, economists, Chancellors of the Exchequer, bankers, oil companies, fund managers – all of the above find themselves involved with an international exchange which reportedly tots up a volume of over $600,000,000,000 a day. It isn't their business; they can't assess the risks and rewards, and yet the risk from currency movements may be the biggest risk they run.

The question is: can currency movements be forecast ? As it happens, here in the 1990s, the currency markets can, I think, be forecast more reliably than any other major financial market. This is odd, if only because of the sheer size of the market. A big free market like that ought to be what academics call 'efficient'. By this they mean that it works so well, that everything that can be foreseen is efficiently discounted in current prices: so no-one can forecast future prices except by luck. But what I am saying is that you can forecast the dollar, systematically, if you follow certain simple rules.

These rules follow from the character of the participants in currency markets. The way the great majority of them think and act dictates the rules. So it does in the other financial markets – stocks, bonds and money markets. But there is a crucial difference between the currency markets and other

financial markets. The difference comes about partly because the currency markets, in their present “floating” form, are so young, dating back only to 1971. The difference is that compared with other major financial markets, the participants in currency markets are naive.

What do we mean by “naive”? The securities markets in the major financial centres have an immense wealth of wisdom behind them. Literally thousands of books have been written about the securities markets. Billions of man hours have been used up by seekers after the secret of what makes securities prices move and how to “beat the market”. This is hardly surprising since the securities markets are a major part of the store of wealth of developed nations, and it’s all quoted, so anyone who had a way of predicting price fluctuations could make a fortune. You can’t quite do this in real estate, which is the other major store of wealth. But you can invest your savings in shares or bondsor real property .You can accumulate wealth through capital growth and income, and the accumulation can, at least in theory, be greatly compounded by timely shifts between shares or property and bonds. And this is the way most investors think and act.

For every thousand stock traders there is maybe only one currency trader

Traditionally, people have never looked at currencies as a major area for investment. Why should they? In the old days, the major currencies tended to be fixed in relation to gold. Even today, after two decades in which currency rates have been fluctuating freely in the same way as securities prices, most people –businessmen and investors alike tend to see currency fluctuations as something external and outside their control. In the securities markets there are millions of people involved whose sole aim is to make money out of price movements. In the currency markets, you have an army of dealers and brokers, whose business is to execute transactions and close their books at the end of the day; you have another army of commercials, including corporate treasurers, whose business is to protect revenues/ assets from financial risk; a host of fund managers, security analysts, and economists whose business is stocks and bonds; a relatively small band of speculators– few of whom have currencies as their main interest; and –wait for it –”about a dozen foreign exchange managers [whole handle straight foreign exchange accounts using specialised approaches. “ The quotation is from a brochure advertising a seminar in New York in July 1991, entitled “Foreign Currency –The New Asset Class”.

So, one way and another, the resources and time that have been devoted to the study of securities over the years have never been allocated to

currencies. That’s why the accumulated wisdom isn’t to be found in currencies. This, of course, is terrific news. Obviously, the fluctuations in currencies offer inexhaustible opportunity for the accumulation of wealth: the good news for you and me is that there is so little competition. Naturally the currency markets offer equal opportunity for losing wealth. But not if we follow the rules which put the odds firmly in our favour. The rules are what this short book is about; the rules about forecasting and about the actual practice of trading currencies.

Not that the currency markets have to be seen as an exclusive alternative to the securities markets. Not so. In the first place, trading currencies doesn’t need to tie up a lot of capital, so you can do it side by side with portfolio investment– or indeed side by side with investment in real assets. Secondly, many of you readers are not too concerned with the investment angle of currencies at all. Your interest is in the business angle. Currency fluctuations, after all, represent one of the biggest commercial risks in your business if it is at all international. They’re an occupational hazard.

The challenge is not to eliminate risk, but to profit from currency fluctuations

In this respect, ‘commercials*’ are in the same boat as investors. We cannot avoid the issue of currency fluctuations, whether we are international businesses or global investors. How does one respond to such a situation? Why, by making a virtue out of necessity. If we can’t avoid currency fluctuations, let’s try and turn them into a profit-centre. This goes as much for commercials as for investors. In fact I think the position of both vis-a-vis currency fluctuations is the same. If you cannot or do not wish to incur currency risks, you can take steps to protect yourself from them, by taking out insurance and hedging* intolerable risks.

But if currency movements can be forecast, then what the game is about is not risk-elimination but risk- evaluated maximisation of performance. And this applies to all of us, commercials and investors alike. So this book is directed to readers who are ready to take up the challenge to try and make money out of the currency movements –or at least save money .And my pleasant job is to show you beyond reasonable doubt that it can be done and suggest how to do it.

But a word of warning to investors. About 99% of the human race is unshakeably convinced that the value of real estate property must rise over time as surely as the sun will rise tomorrow; and that any pause in this remorseless trend will be momentary. You find the same universal conviction among followers of equities. It’s taken for granted that bear markets and crashes are just buying opportunities which pose no threat to the inexorable rise and rise of stock prices. And there’s a whole industry out there devoted to persuading people that capital growth and equities are synonymous, and stocks are the only serious way to beat inflation, and all well-informed people know this, naturally. The post-war history of stock markets and property markets has encouraged these mindsets* – though if you take off a couple of minutes or three to think about it, you will agree that the more things have done this in the past therefore the more people are convinced they will continue to do so for ever –the less they are likely to do so in future… because prices have been driven up in exact proportion to the conditioned expectations of those who think in this way. The people who thought that way about precious metals have had second thoughts. Gold and silver have long been the basis of money. In the old days when the two were interchangeable, the basic difference was that money earned interest and was susceptible to devaluation through inflation. This hasn’t changed, following the terminal separation of currency and gold in 1971. Over very long time-spans, the price of precious metals can be expected to follow trends in general inflation and mining costs. But mean– while, if you think about it, the relationship of gold to money has to reflect changes in the “real” interest rates, adjusted for inflation.