Wednesday, 14 January 2009

Profiting from the misery of others

George Soros

My wife was visiting friends in the UK recently. Mary, an active investor, asked how my investing was going (we've swapped info and opinion on stocks going back to before the dot com thing). My wife replied that these days I was mostly trading currencies. At which point Roger, the husband, launched into a tirade pretty well blaming me, and if not me, then others like me, for global financial misery, and damned me for profiting from the same.

Wow. Well I was quite flattered really. I was also surprised by his ignorance (I know the man has a PhD, but that doesn't mean he's stupid).

I wondered how many people think like him, so I decided to flesh the thing out a little in case (a) you think as he does or (b) you are vaguely interested.

The first thing to grasp is that you don't just buy or sell pounds. Currencies are always traded in pairs. If you "sell" the pound, you are buying dollars, or yen, or another currency.

But you have already done this when you go on holiday. If you go to the States, you may think you are exchanging your money, but you are actually selling pounds and buying dollars. And vice versa, if you have any dosh left at the end of your holiday.

In a way, all transactions are based on pairs. The shirt manufacturer is selling shirts and buying pounds, exactly the inverse of the M&S buyer, who is selling pounds and buying shirts.

Which brings me round to reciprocity. There are always two sides to the transaction. It's not as if you somehow sell your dollars into a big dollar warehouse somewhere. When you sell dollars (and buy pounds) someone around the globe has just bought your dollars and sold you their pounds.

So where do evil speculators come in? It's hard to see. From the above you will understand that I can't just "dump" pounds. Someone, somewhere, will be buying them with exactly the same enthusiasm as I am selling them. Reciprocity.

Sure, if there are lots of pounds because Gordon is running the printing presses day and night, or folks think that UK plc is stuffed, then someone won't want to give up their dollars for them quite so readily, and can only be persuaded to do so if you chuck in a few extra quid. And in this way the pound falls against the dollar.

Am I an evil speculator? Well I try and anticipate the direction of a move. If I believe that the pound will lose value against the dollar, I will sell pounds (and buy dollars) and later buy back those pounds using fewer dollars and keep the difference -- but only if I'm right. Otherwise, it is I, the evil speculator, who will have to buy back those pounds for more dollars than I originally got for them, and I lose! (And my opposite number wins). It's a zero sum game.

M&S does exactly the same thing. If the price of shirts moves against them, when they come to buy pounds by selling shirts, they will get fewer pounds than they may have parted with originally. They lose.

But can speculators move markets? Not really. About $4 trillion is traded daily around the globe. That's a lot of money. Consider that the war in Iraq has "only" cost half a trillion so far ... So no individual or organisation short of a government could swing a forex market. And even governments can't as John Major found to his cost: Black Wednesday, 1992.

They were frantically buying pounds and selling foreign exchange to prop up the "value" of the pound. George Soros was happily selling them pounds and buying their foreign exchange - he was simply the other side of the zero-sum game. The government got very cross with Soros, but in effect handed him a $1 billion profit. The overall loss to the UK was about $6 billion

If they were really smart they would have sold the pound too. History shows that they could then have bought it back later at a cheaper rate and the billions in profit would have come back to the hard-pressed UK taxpayer.

No, I'm not taking the piss, I mean it.


Mud in the City said...

Oh - it is too early in the morning for me to read that and think anything othre than "......."

I'm keeping my pounds under the bed (just don't tell anyone!)

Lulu LaBonne said...

When my stepson was young and wanted to go to Disneyland, his father explained that it wasn't possible because he didn't have enough money, the 5-year-old's response was
well go out and buy some then

Nota Bene said...


That's truly the most dis-ingenious piece of writing on the subject I've seen! But it nicely argued!

Of course the pickle we're in is not your fault, nor that of any one individual. But speculators are herd animals, and they move with undue haste to protect themselves, or to make their margin. They create a momentum that does have significant economic impact...not just in the real sense, but also on the collective psychology.

I can't see that reciprocity is a zero sum game...after all it is the differentials and changing relative values that make capitalism work.

Speculators are, of course part of the system...they are what drives the market forward...either up or down, but as in any system, there need to be effective rules - and we're where we are now because the rules allow, indeed encourage, large swings and that damages the economic environment.

Having said all that, there was a briliant programme on the Beeb last night, and evidently it is entirely the fault of David Bowie. I never liked his songs anyway.

SJW said...

Succinct as always Edward.
Hope you've been spending time on the sunny side of that zero sum.

Janelle said...

oh fuck. i bought kwachas.....

Ernest de Cugnac said...

mud - just exactly where is your bed? (No, don't answer).

lulu - ah, out of the mouths of babes and sucklings.

nota bene - "dis-ingenious" ... I wonder which you meant? Not ingenious, as in the opposite of ingenious, which I guess is "stupid" or not ingenuous as in the opposite of straightforward and candid, which is "unworthily or meanly artful".

sjw - as it happens I am on the sunny side of the zero sum :)

janelle - could be a good move ... if the other currency in the pair is the pound, you'll be a winner!

Absolute Vanilla (and Atyllah) said...

Brilliant summation of how it works!
I always take my hat off to Soros and thumb my nose at the Brits for that colossally dumb move of theirs.

Baino said...

How speculators are to blame escapes me . .it's more the panic merchants who withdraw their assets from any market, currency or equities that cause the ructions. As long as you're keeping on your toes and prepared to take a loss with the risk keep it up I say. As for PhD's all brains doesn't necessarily mean intelligence . .then what do I know, the best I did was a BA

Ernest de Cugnac said...

av - I remember the day well. Major and Lamont were in a right panic and at one stage hicked interest rates to 15%. I had a mortgage! I think they brought it down in a few hours, but it shows how out of control they were.

baino - I've never seen the Tshirt, but somewhere I've come across the following brilliant caption for one: "I may have a PhD, but that doesn't make me stupid".

Actually, I do have a PhD and it is about the dummest waste of time I ever went in for. It proves you have the idiot persistence to crawl along the frontier of knowledge with a magnifying glass, and not much else.

i beati said...

great article-sandy

claires inner world said...

To quote ABBA,

Ahhh ahhh, ahh ahhhh.
All the things I could dooooo
If I had a little money,
It's a rich's man world.

Ernest de Cugnac said...

i beati - thank you kindly

claire - now, come on, how about a .wav with you singing??

The Dotterel said...

I think this needs a wider audience, Ernest. Meantime, pass the hat round will you?

Ernest de Cugnac said...

Hi dotterel - thanks. And in these days of turmoil, I think there is a risk that someone will dump the money and keep the hat.

Jolly Good Yarn Girl said...

Maybe it WAS worth keeping my Dad's stamp collection??

Ernest de Cugnac said...

without doubt jollygood, you can always boil them down for soup.