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How does Currency Manipulation Work?

By Louis Holding-Parsons on August 21, 2019

5 (100%) 2 vote[s]

Currency manipulation is the opposite of a freely floating currency. Manipulating a currency is performed by governments who are seeking a pre-determined result. This will require their intervention in currency markets so as to get the outcome they desire.

An economic beauty parade…

Currency manipulation is one of the easiest economic policies available to governments. As a rule, few governments want their currency to go up. All currency manipulators are usually trying to weaken their currency: make it cheaper. In effect it an economic beauty parade! Weakening the price of your currency versus another makes your exports cheaper. Countries rely on exports to create wealth. It means companies within that country are successful which creates jobs and increased tax receipts for governments.

Freedom to act

Currency manipulation is usually government ledEconomics is a process of trial and error. There is no one size fits all. Different solutions might seem similar but are subtly different and will fit different systems. For currencies this is centered on free floating interest rates. In a stable political system where there is an independent judiciary and central bank this means that biased economic management can be denounced. In turn it means that currency manipulation is not required.

Central bank independence… or lack of

The problem is regimes which are pursuing policies which are creating economic problems. Just look at Turkey where President Erdogan’s authoritarian style of leadership has led to concerns that its central bank is no longer independent.  A central bank which is not independent means it’s benchmark interest rate (a key influencer in the price of a currency) will be moved according to government policy rather than perceived economic necessity.

Currency manipulation can lead to regime change…

Currency manipulation can lead to victimsInflation and Forex are difficult to control at the best of times! In this instance, President Erdogan has tried, unsuccessfully, to manipulate central bank policy by demanding that the interest rate be raised. Soon after the governor of the Turquish central bank refused to bend to this interference, he left his position. I let you make your mind up why. In the meantime the Turquish Lira has continue to trend downwards. 

Erdogan's attempts at currency manipulation have not worked

So does Currency manipulation work?

Overt currency manipulation can work for a while if the market agrees with you. This is because other traders will agree with your analysis and trade with you, not against you. No institutional trader will enter into a trade if they think they will lose money. In September 1992, the U.K. tried to keep Sterling to a pegged exchange rate which was unsustainable. Traders realised this and shorted Sterling. Eventually the UK treasury realised it could not win and accepted the estimated £3.4bn losses. This is an excellent example of where currency manipulation did not work. 

Tools to use

Failed currency manipulation led to the pound losing valueIf we use the example of “black Wednesday” above, the UK deployed several weapons to fight back. Firstly it got the Bank of England to spend its foreign currency reserves by buying Sterling. Secondly the UK Treasury raised interest rates from 10 to 12%, with the hope of making Sterling more attractive. (The BoE did not have independence at the time). Neither worked. You cannot control Forex markets by acting directly, you can guide them to a suggested better place, where everyone involved will make money. A retail Forex trader should never forget that markets are a pricing mechanism. if the market does not agree with you, it will not allow you to manipulate it!

Conclusion

Devaluation of currency through currency manipulation is a touchy subject today. Trump’s trade war with China regarding their use of the Yuan to help with their competitiveness has led to accusations of China being a currency manipulator. For a proud country like China, this can only lead to retaliation which often leads to trade wars and Forex currency manipulation. Whether this is sustainable is going to be interesting to watch!

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Louis Holding-Parsons

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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Louis Holding-Parsons

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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