International Finance and Financial Policy

By Hans R. Stoll | Go to book overview

7
Understanding the Foreign Exchange Market

SCOTT E. PARDEE

There is one thing that I learned from Charles Coombs at the New York Federal Reserve Bank, and that is to ask "Who is doing that and why?" Back in July 1972, we had negotiated a resumption of intervention by the Federal Reserve after the Smithsonian Agreement. In the market we offered 30 million deutsch marks and it was snapped up right away. We really wanted this operation to work, and the DMs just disappeared. Coombs asked, "Which bank did that?" He was given the answer that it was one of the major U.S. banks, and he asked, "Why?" Nobody knew the answer. Well, it turned out that the Germans had tightened their money market. The Bundesbank pumped about 400 million DMs into the market at the same time, through its discount window. If we had continued to intervene, we would have simply done an open-market operation for the Bundesbank and not had any success with our intervention.

Therefore, as you approach a market, you ask two questions. First, who are the other people involved in the foreign exchange market at this time, and second, why are they trading? As an answer to the first question there are speculators, commercial bank traders, and traders who are with securities houses; there are some central banks. Over the years we have had a number of Latin American central banks, Asian central banks, and even the Soviet Union being active in the market as speculators. Speculators do not really care whether the dollar is going up or down. This is an important function in the market, and I have played the role sometimes myself. Another group of people you have to follow are the corporate accounts (exporters, importers, and major companies). They will from time to time be speculators, as some of the German and French automobile companies have been, but they also have to consider their long- term needs and whether they will hedge those needs or will hold a position over the long term. When these people move, they move very, very big amounts,

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