They're all speculators now
It wasn't just the sharp-suited City dealers who made money out of sterling's
collapse; the cream of Britain's corporations were all furiously selling
pounds to make up for the fact that they can't sell much else. Tony Kennedy
After the pound's collapse on the foreign exchange (forex) markets, speculators
vied with the German Bundesbank for top spot on the British media's hate
list. Newspapers conjured up lurid images of flash yobbos making millions
by bringing down the pound. 'Baying barrow boys in expensive suits with
loud ties' were clamouring to 'kill sterling'. 'Essex men with white socks,
closely cropped heads and a handful of GCSEs' apparently couldn't give a
forex about the pound. While Norman Lamont was saying high-minded things
about the sanctity of the Exchange Rate Mechanism (ERM), 'Trevor, Mark,
Andy and Yosser were deciding the future of the British economy' with their
vulgar broker-babble: 'Go on my son, give me seven.'
Worse still, the irresponsible oiks laughed and joked all the way to the
bank: 'Eh! There's a bloke on the phone says he wants to buy sterling. Says
his name is Lamont.' With a tidal wave of sell orders engulfing the pound,
journalists cried treason and informed their readers that 'currency barbarians'
were guillotined during the French Revolution.
Huge profits were indeed made in the forex markets through massive selling
of the pound and other currencies. But the idea of self-serving wide-boys
tarnishing the clean image of British business is wide of the mark. Closer
scrutiny reveals that the profiteers who made the big money from the pound's
collapse in September were the cream of the British financial and corporate
The brash youths at computer terminals playing Nintendo war games with the
world's currencies learn their trade from their seniors in the City hierarchy.
They take their orders from a chief currency dealer - likely to be a slightly
balding, slightly overweight, thirtysomething paragon of City respectability.
The chief, meanwhile, is responding to noises from further up the line.
The insistence on making a quick financial return by any means originates
at the very top.
The dealers trade currencies on behalf of the biggest names in British and
world banking: the UK high-street banks, big merchant banking outfits from
Britain and abroad, and the larger building societies. They deal from emporium-sized,
state-of-the-art, high-security rooms with technology providing instant
link-ups with the rest of the market. The huge expense of these operations,
the intense competition and the fleeting nature of opportunities to make
a killing all serve to encourage a quick-buck culture.
According to Bank of England estimates, the turnover in the forex markets
worldwide amounts to about $1 trillion per day - that's twice the annual
output of the UK economy. The figure represents a doubling of forex
business since 1986. On average, only about 15-20 per cent of this activity
reflects business transactions by companies. The main component of currency
trade is known as inter-bank dealing - banks shifting their financial resources
in and out of different currencies. The impetus behind the growth of inter-bank
currency movements is the volatility of exchange rates. Banks fear being
caught holding large amounts of a falling currency and look for opportunities
to acquire currencies that they expect to rise in value.
Exchange rate volatility has also been the major force behind the growth
of currency futures and options business (see box). A recent survey by the
Economist noted that the currency futures and options trade globally
has risen from $1.1 trillion in 1986 to $6.9 trillion in 1991. The need
for cover against exchange rate movements has become much more pressing
over the past decade.
These huge rises in forex business provided a major boost for the British
economy in the 1980s. The City has managed to sustain its position as the
single most important centre for forex business, accounting for about a
third of the total worldwide. British financial institutions have reaped
handsome rewards in the form of brokerage fees and commissions from forex
business. They have also used their expertise in the forex markets to make
profits out of inter-bank dealing. During the eighties, foreign banks flooded
into London in order to ensure a foothold in the leading forex market - so
much so that there are now more American banks operating in London than
in New York.
The politicians and press who are now bemoaning the lack of control over
speculators were not so long ago heralding the wisdom of Tory moves to deregulate
the City. The 'Big Bang' strategy which hauled down many of the barriers
to money dealing and share trading in London was seen as one of the most
clear-cut success stories of the Thatcher years.
Far from being a burden on the British economy, the money-grabbing activities
of the City dealers have helped to carry capitalism in this country for
years. The truth is that British industry risks falling into a comatose
state without a regular financial fix begged, borrowed or ripped-off in
the City. The recent ups and downs in the share and currency markets provide
an example of how this works.
During 1991, 143 British companies took advantage of a revival in the stock
market to raise a record-breaking £9.2 billion through rights issues.
Rights issues are an invitation to existing shareholders to buy newly issued
shares in a company. Conventional investment theory states that rights issues
are a way in which companies can raise finance for new investment. The recent
rights issues by British companies, however, were less than conventional.
Much of the proceeds from the rights issues have been used to pay off debts
built up in the eighties. The idea has been to replace debt, on which high
interest payments are due, with equity, upon which there is no legal obligation
to pay dividends. Of course, the prospect of dividend cuts is not a good
advert for purchasing shares. Hence the bizarre spectacle in 1991 of corporate
Britain maintaining, and even increasing, dividend payments to shareholders
as profits collapsed. The aim was to sweeten the rights issues to ensure
a successful sale.
This year, with no recovery in sight and profits still falling, dividend
payments have had to be slashed. The result has been that the share prices
of these companies, in the words of the Sunday Times, 'have all bombed'.
The £9.2 billion in rights which were bought, mostly by the financial
institutions, in 1991 have effectively become worthless pieces of paper.
The immediate losers were the pension funds and insurance companies that
dominate share ownership in Britain. Their unhappy experience with the rights
issues led them to offload shares and bank the cash at high interest rates.
The irony is that the larger than usual amounts of cash held by the pension
funds and insurance companies meant that they were able to act quickly,
and on a large scale, in dumping pounds for stronger currencies in September.
What they lost on rights in 1991, they no doubt regained in dealing when
the pound took a dive.
British companies are reticent about revealing the profits made from the
pound's collapse. What is certain, however, is that with industrial decline
at home they have had to become adept in the arts of currency management
in the forex markets. A growing dependence on the import of expensive high-technology
goods exposes UK corporations to the risk of higher costs when the pound
falls against other currencies. Lower profit rates in Britain have also
encouraged companies to buy shares in foreign firms, making profits more
vulnerable to currency movements. Leading British companies were among the
biggest buyers in the cross-border takeover binge of the 1980s. Around 40
per cent of UK corporate profits now originate abroad.
All of these factors have forced British companies to put resources into
tackling the financial risks which arise from volatile exchange rates. While
British investment in productive capacity has been derisory, expenditure
on money management operations has been generous. The treasury departments
of large companies in Britain today often have a higher profile than the
production or sales departments. The best brains and most ambitious will
typically be found on the financing side of corporate operations.
Indeed, the last decade has been marked by a growing trend for corporate
treasuries to conduct business in their own right on the forex markets.
Much of their activity has little to do with financing their basic production
operations. They have adopted a more active money management philosophy,
using reserves to make profits in the currency markets in much the same
way as financial institutions. Unable to make sufficient profits by producing
and selling things, Britain's industrial and commercial giants have tried
to compensate by playing the currency and share markets. Typically, the
Sears corporation, which is in the middle of closing down its unprofitable
shoe shops, recently announced that it made 60 per cent of its profits last
year through financial deals.
Against this background, it is hard to believe that British corporations
did not enter into the speculative rush against the pound in a big way.
Making money from the pound's collapse was unusually easy. The Bank of England,
the Bundesbank and the Belgian central bank were buying pounds at the ERM
lower limit of DM2.778. On numerous occasions during the days of panic selling,
the pound was trading in the markets at around DM2.65. Anyone holding deutschmarks
could have bought a pound for DM2.65 and a short while later sold it to
the central banks for DM2.778. Alternatively, holders of pounds could have
sold them when the central banks intervened for DM2.778, and then bought
them back for only DM2.65.
Blaming loud-mouthed currency traders for the pound's collapse ignores the
fact that the people on the other end of their phone lines placing 'sell
sterling' orders included the blue chip representatives of corporate Britain.
A reputed £1 billion in straight profit was made in those few days
in mid-September when the pound crashed. This is a sum UK banks might normally
expect to earn in a six-month period of business. The currency dealers did
very well. However, many other sectors of British business invited themselves
along to the feast.
When the banks were attacked for profiteering during the sterling crisis,
they replied that their ability to exploit the situation had in fact been
restricted by Bank of England rules; the biggest profits from selling the
pound, they insisted, had been made by the fund management groups and by
the treasury departments of Britain's major companies. It is a sign of how
far the economic rot has set in that the biggest money-making deals of the
year should involve British capitalists cannibalising their own currency.
End of business
While British capitalists have been making millions from ventures into the
forex markets, they have been closing down what's left of manufacturing.
The crisis at British Aerospace (BAe) is eloquent proof that they have little
in reserve other than their parasitic forays into the financial markets.
A showpiece privatisation back in 1981, BAe registered a loss of £129m
in the first half of 1992 and a share price back at its 1981 level. This
ailing company is all that's left of the UK aircraft and car industries,
and constitutes a large slice of the defence industry.
BAe's position is so desperate that even with the knockdown share price,
the takeover specialists and asset-strippers in the City have shown little
interest. They must be saving their ammunition for the next currency crisis.
What's it forex?
The forex markets embrace a variety of financial arrangements. The spot
markets cover currency transactions for immediate delivery (within two days).
In the forward markets, exchange rates are quoted on currencies to be delivered
in the future (eg, in one month). Forward exchange rates diverge from spot
rates and are determined by the market consensus on how currencies are likely
to move in the near future. If the market expects the pound to fall against
the deutschmark in the next month, then the one month £/DM forward
rate quoted today will be lower than the spot rate today.
There are also markets in currency futures and options. Like the forward
exchange agreement, a futures contract involves the exchange of one currency
for another at some pre-determined rate in the future. However, futures
differ in a number of ways. First, futures markets exist only in a small
range of major currencies where turnover is high. Second, the contracts
are tradeable assets able to be sold on to third parties. Third, futures
are issued in standardised packages; a futures contract to exchange deutschmarks
for dollars must be issued in DM125 000 units.
Options provide the additional facility of giving the contract holder a
choice as to whether to go through with the deal or simply let the contract
lapse. Of course, this additional right comes at a price. The key feature
of forward agreements, futures and options is that they provide insurance
against the risk of financial loss on other deals due to exchange rate movements.
Reproduced from Living Marxism issue 49, November 1992