OlsenBlog

For the last 25 years you have been trying to make currency investments more efficient. Given the distortions in the market today, isn’t this an impossible mission?

Richard Olsen: I don’t think so. However, the current distortions in the market show that the economic mechanisms behind the foreign exchange markets are not understood well enough. In particular, the fact that the economy is not static, but in a constant state of change, is ignored. The situation is comparable to classical physics before 1900: only Einstein’s theory of relativity, which took the dynamical behaviour into account, allowed for a breakthrough.

So economics needs a new Albert Einstein?

RO: It needs new ideas. Indeed, there already exist new scientific models and algorithms, which incorporate the dynamical aspects. Now it is all about applying them. The methodology of High Frequency Finance offers a possibility.

Does this mean that the attempts of the recent crisis summit addressing the strong Swiss franc have fallen short?

RO: The problem is, that people try to directly influence the level of exchange rates. This, however, destabilizes the whole currency system even more.

What advice would you give the Swiss currency experts?

RO: A first step would be to dampen the massive exchange rate fluctuations in the franc. For instance, this could be achieved if exporting firms would hedge their foreign exchange risk dynamically. Thus buying Euros now as long as it is cheap, and selling when the franc drops again. This would substantially stabilize the exchange rate of the franc.

But hedging is the business of banks. Does this really require the presence of the government?

RO: Not necessarily. There simply has to be a clear signal that new solutions exist and are ready to be utilized. It takes courage to do new things, but necessity begets ingenuity. We need to support this process of innovation.

Will the franc become stronger against the Euro?

RO: The franc has risen strongly against the Euro in the last five weeks. This can hardly continue at the same rate, particularly as the exchange rate rise can most probably be attributed to the low liquidity around the holidays and the subsequent re-buying. Another recovery of the Euro rate is therefore probable.

But the fact that the eurozone countries currently don’t agree on the amount of funding for rescuing the Euro hardly speaks for it?

RO: Europe has many problems. But the impact of such news on the exchange rate is smaller than one would think: 95 percent of an exchange rate volume is based on speculation and only 5 percent can be ascribed to the real economy. The exaggerations seen in the rates occur because speculators are being forced to sell at a certain price, if they hit their stop loss, lowering the rate even more and scaring off more investors, similar to a herd of sheep plummeting over a cliff.

The Dollar is also under pressure. The Fed will soon be deciding on the interest rates – can they change the course of things?

RO: Here also, has it become evident that the wrong recipes are being applied. Interest rates in the financial system are not paid in a continuous manner but daily. This is in contrast to the financial markets where huge volumes can be traded in a split second. The market does not need more liquidity but interest rates paid every second for intervals of minutes or hours. This would also remedy the side effects of low daily interest rates.

Contrary to the USA, China is increasing the prime rates more and more aggressively: as a result, will the frictions in the foreign exchange market increase yet again?

RO: For the foreign exchange market the central banks appear as imps, who fix everything behind the curtains. Meanwhile however, there has been no consensus among them. In a dynamical system this leads to an increasing imbalance. Yes, the friction in the foreign exchange market will increase strongly.

Higher interest rates are commonly put forward as an argument to invest in the currencies of emerging countries.

RO: From the point of view of a diversification strategy this makes sense. However, it should not be forgotten that in the booming emerging nations, prices can also increase strongly, for instance for property. This can be very risky.

Given the risks, opacity and often the unfavorable spreads, shouldn’t private investors totally avoid the foreign exchange market?

RO: There is a big demand for currency investments and these requirements should be covered. Investors should, however, better focus on lower but steadier returns and minimized risk. The partly dubious offers that are available are, if nothing else, due to the fact that large suppliers are not innovative enough and charge very high prices. A little modesty would also benefit the foreign exchange business.

(Source: Handelszeitung)

January 24th, 2011 | Economics, General, High frequency finance, Market | RSS feed