From the real economy to the speculative (excerpts)

Remarks by Bernard Lietaer at International Forum on Globalization (IFG) seminar, [15 December 1997]

In the following excerpt from remarks at an International Forum on Globalisation (IFG) seminar, the writer focuses on the alarming increase in global currency speculation. The potential implications are truly explosive, threatening global power arrangements, the sovereignty of nation-states, and the abilities of ordinary people to survive.

In 1975, about 80% of foreign exchange transactions (where one national currency is exchanged for another) were to conduct business in the real economy. For instance, currencies change hands to import oil, export cars, buy corporations, invest in portfolios, or build factories. Real transactions actually produce or trade goods and services.

The remaining 20% of transactions in 1975 were speculative, which means that the sole purpose was an expected profit from buying and selling currencies themselves, based on their changing values. So, even in the days when the real economy was dominant, some currency speculation was going on. There had always been that little bit of frosting on the cake.

Today, the real economy in foreign exchange transactions is down to 2.5% and 97.5% is now speculative. What had been the frosting has become the cake. The real economy has become just a small percentage of total financial currency activity.

My estimate is that in 1997 we will have close to $2 trillion in currencies being traded per day. This is equivalent to the entire annual gross domestic product (GDP) volume of the United States being turned over via currency trading every three days.

There are three cumulative causes for this explosive increase in currency speculation:

• Systemic redefinition. The first important act was former US President Richard Nixon’s unleashing of the dollar from the gold standard in 1973. Floating the dollar allowed currency values to be determined by traders in currency exchange markets. Currencies from countries with strong economies and sound monetary and fiscal policies were given more value than currencies from countries with shaky or weak economies and policies. This opening of the system created a framework for the speculation game.
• Legal deregulation. In the 1980s, both former US President Ronald Reagan and former British Prime Minister Margaret Thatcher introduced deregulation strategies. The Baker Plan, implemented by the World Bank and the International Monetary Fund (IMF), applied those changes to a dozen key Third World countries. This created a lot more leeway for movement of capital internationally, and for corporations that previously would not have participated in speculation.
• Technology. The structural, deep-lying phenomenon behind the whole system, is the technological shift: the electronification of money and the computerisation of market systems.

The Business Viewpoint

Economic textbooks say that corporations and individuals compete for markets and resources. This is not true. Corporations and individuals compete for money by using markets and resources.

The opening of the system, which led to floating exchanges, also created a new asset class. Traditional asset classes are real estate, bonds, stocks, and commodities. Today, we also have currencies. This means that money, the medium of exchange, has itself become an asset to be played into investment portfolios. This shift has different implications for businesses, depending on whether you’re an investor or a real business.

From an investor’s viewpoint, this new asset class—currencies—has some significant advantages over the old ones:

• Extraordinarily low transaction costs. Placing a few billion dollars in foreign exchange costs very little; as much as 10 or 20 times cheaper than a stock transaction.
• Twenty-four-hour market environment; one can actually play around the clock.
• The foreign currency market is the largest and deepest market around by a long shot. If you have a few billion dollars to place, bringing them to the stock market is going to move the stock’s value and tip off other traders as to what you are doing. This is true in most bond markets (except for the US and some European markets because of their large size).

In foreign exchange, even five or ten billion won’t make a blip. So if you have a substantial amount of money to move around, this is the place to do it. You can get in and out without affecting the market.

Because of these three advantages, the act of lending money to people (to buy houses, cars, expand businesses or whatever) is no longer the best way to make money. The foreign currency market is the place to do it.

Banks are no longer the big players in terms of supplying credit. In the last 25 years, banks, as a source of financing in America, have dropped from 75% of the total supply of credit to 26.5%. For the major international banks, like Chase Manhattan, Citicorp, Bank of America, Barclays, or Sumitomo, currency trading typically accounts for at least 20% of total earnings. In a good year, it will be more than 50%.

In considering the viewpoint of so-called real businesses (those that make cars, mine, produce electronics, etc.), the foreign exchange risk has by far become the largest risk in international business today, often larger than political or market risk. For example, if a German chemical company invests in a plant in India, it makes the investment in deutschmarks. The chemical products sold locally from that plant are paid in rupees, India’s currency.

If the value of the rupee than drops in terms of the deutschmark, the return on the original investment will drop as well. In short, the biggest risk of such investments is not whether Indians will buy the chemicals (market risk) or whether the Indian government will nationalise the plant (political risk), but the changes in the values of the currencies involved (foreign exchange risk).

Corporations have followed two major strategies to deal with this risk.

The first strategy is the reorganisation of the corporate conglomerate. Production and marketing sectors are decentralising because the risk doesn’t lie there, and because adaptation to local circumstances can best be handled on a local level. This also leads to the dispersal of production facilities to other countries.

But while marketing and production are decentralising, the corporation’s financial and treasury functions are being centralised. Twenty or 30 years ago, when an American company had a big plant in Germany, the plant would handle its own finances. Not any more. Now, this is all done centrally at corporate headquarters.

The second strategy that large corporations pursue is an adjustment of their executive officers. In the 1940s and 1950s, anybody who could manufacture any product could sell it. So, a manager with a background in production or engineering would typically be made the CEO. In the 1960s and the 1970s, that shifted. Suddenly marketing was the key background necessary for people at the top.

However, in the 1980s and 1990s, finance specialists are in charge. They are the ones who call the shots. That shift in career paths has also changed the corporation’s outlook, and is a reaction to the new risk that we are talking about.

Now, I have two questions for you:

First: Who do you think is the largest private financial institution in the US today? It is General Electric (GE). The largest profit sector in GE is not defence, not light bulbs, not power stations. It is GE’s treasury department, because of its many financial transactions.

The second question is: Who do you think is taking the largest foreign exchange risk? It’s everybody who holds only one currency. That is, most people. Anyone who owns their own house, which sits in one currency (like dollars, deutschmarks, or yen), and who has their savings and income in that same currency, is at the greatest risk. By holding only one currency, they risk all their assets being devalued in the event of their currency crashing. In a world of floating exchanges, not being diversified in currencies is like having a stock portfolio with only one stock.

Three Consequences

The first consequence of this state of affairs is that national governments are in the process of losing power. The nation-state is the one entity that cannot manage in this new climate. It has no way to gain power against global capital and information technology.

Currency traders are effectively policing governments by selling off a nation’s currency when they are dissatisfied with that government’s policies. If enough traders act together, the value of a currency can plummet, creating a currency crisis. These sudden large sell-offs are viewed by governments as attacks on the value of their currencies.

Currency devalution can happen in a very short time, days or even hours, because of the new global communications system. There are no negotiations, there’s no talking, there’s nobody sitting around a table saying, This is what we’re going to do, or, How about re-negotiating this part? That’s not the way it happens. You just suddenly end up with a crisis in a particular country’s currency. Such was the case with the collapse of the British pound sterling in 1991, the Scandinavian currencies in 1992 and 1993, and Mexico in 1994.

One of the things to watch for in the future will be such a devaluation of (an attack on) the US dollar, which is the linchpin of the whole system. Now, one might ask, Why would traders want to pull out the linchpin? Well, from an individual trader’s point of view, it doesn’t matter which currency you profit from, you just trade. If enough traders see an opportunity to profit by the dollar’s fluctuations, they will exploit it because nobody believes that his or her individual action will bring down the entire system.

Central banks can often intervene when a currency is under attack by either buying or selling to counter speculators. But the volumes of money now being traded are so vast that even central banks may not have an impact. All the reserves of all the central banks together amount to about $640 billion, so all their reserves could be depleted in a third of a normal trading day.

This points directly to a second consequence: a growing interest in market instability because that is where one finds the opportunity for windfall profits. Big fluctuations in the values of currencies allow for big profits to be made by trading them.

Consider the following statements by leaders at opposite ends of the spectrum:

The biggest concern today is the growing constituency for instability.
—Paul Volcker, ex-governor of the US Federal Reserve, in Changing Fortunes.

Instability is cumulative, so that the eventual breakdown of freely floating exchanges is ensured.
—George Soros, the largest currency speculator today, in The Alchemy of Finance.

They both agree that there are many more people now who have an interest in profiting from instability; previously, they had an interest in stability. If you have an unstable system, it is just a question of when it will fly off the handle. It will blow apart at the moment when the US dollar experiences a crisis. When the dollar crisis occurs, the world will have no system left.

The only precedent I know is the collapse of the Roman monetary system. In the 1929 crash, the monetary system held. We had all kinds of other problems—unemployment, stock market crashes, currency inflation in Germany—but there was a gold standard that held. Today, we have no gold standard to fall back on. So there is no precedent for a collapse of this nature. And this would be a truly global phenomenon. All currencies in the world are based on the dollar. So if you have a crisis on the dollar, you pull out the linchpin and... boom.

The third consequence is something with which you are very familiar. As a great portion of the national currencies—about $2 trillion per day - is being turned around in the financial cyber-economy, there is just no satisfactory medium of exchange available to people at the bottom. National currencies are not widely available to the poorer parts of the population.

The age of labour as a key component of production is gone. If you don’t have a job, you don’t have money (ie, national currency). Even despite the fact that structural unemployment is increasing, the economy can continue to grow very well. Technology will shift us still further in that direction.

What is beginning to happen in the developed countries is a new phenomenon: an explosion of local currencies—money that is not the national currency. We haven’t seen this since the Great Depression when there were literally thousands of local currencies in the US and other countries affected by massive unemployment. By supporting the development of local money schemes, we may in fact create the groundwork for the next system. This could become one of the most powerful ways available to support citizen control.—Third World Network Features