haustively, then certainly in sufficient scope and detail to be able to make a measurabledifference to their bottom line. Talk is cheap. The point of this book is to make a differenceto the total or relative returns of investors and speculators, and in terms of reducing hedgingcosts and boosting the profitability of corporate Treasury operations. It is my sincere hope thatit has gone some way to achieving this aim.
11Emerging World: New Growth Marketsfor Global FXThus far in this book, we have taken a detailed look at both the theory and practice of the globalFX market. As the latest surveys from the Bank of International Settlements (BIS) confirm,the vast majority of FX trading volume is still done in the “major” currencies such as the USdollar, Euro, Japanese yen, Pound sterling, Swiss franc and so forth. Indeed, as of the 2004BIS survey, three exchange rates – EUR–USD, USD–JPY and GBP–USD – make up around60% of total FX volume. However, the same survey also shows a dramatic rise in tradingvolumes of Emerging Market (EM) currencies and particularly those of Asia. Whereas globalturnover grew by 57% in 2004 from the 2001 results, activity in many Asian currencies greweven faster.1 This is closely in line with the increasing importance of the EM as an asset class.
11.1 THE GROWTH OF EMERGING MARKETS ASAN ASSET CLASSFrom being a niche asset class, EM currencies have finally come into their own in the last fiveyears. Exchange rates have been liberalized, their capital accounts have been gradually openedup and the result has been explosive growth in both volume and liquidity. Granted, there aresome notable exceptions to this. Nevertheless, this is clearly the overall trend. In FX, EMspot, forward and options are now a major growth business and those banks with significantoperations in EM countries look best placed to exploit this business opportunity. In this section,we highlight the main reasons why this has happened and try to give some foresight as to howthese trends are likely to continue.Between 1997 and 2002, the EM asset class experienced a series of spectacular currencycrises, including those in Asia (1997–1998), Brazil (1999), Ecuador (2000), Turkey (2001)and Argentina (2002). Currencies collapsed, credit spreads exploded and so-called “crossover”investors, which unlike “dedicated” investors are not benchmarked to EM but instead see it asan “off index allocation”, ran for cover. For speculators, potentially rich pickings were to behad, but for so-called “real money” investors this was a potentially very damaging environmentfor long-term investment prospects. As a result, crossover investors not only left, but stayedaway for quite some time have been burned by the process. Since then, however, EM has beenon a long and winding road back to recovery, given the following factors:
r The implementation in a number of IMF programme requirements in those instances ofcurrency crisis
r The introduction of IMF information dissemination standards, boosting transparencyr Stronger and more consistent macroeconomic policy implementation, both by countriesunder IMF programmes and those that were not1
Bank of International Settlements (2004), Triennial Central Bank Survey.
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r Inflation targeting and fiscal rationalizationr Globalisation, resulting in G10 corporations moving increasing production capacity to EMAt the time, currency crises resulted in collapse in domestic demand, triggering massive currentaccount balance swings from deficits to surpluses. Crucially, this gave the countries concernedan economic buffer against further shocks, reducing dependency on portfolio inflows, andsome breathing space to enact necessary reforms. As a result, EM countries:
r Have reduced internal and external deficits through fiscal rationalization and exportpromotion
r Improved economic safety guards via the acquisition of FX reserves on the back of sustainedimprovement in current account balances
r Enacted prudent liability management in order to reduce national exposure to higher globalinterest rates
r Encouraged pro-active government policy to boost productivity, thus further supporting moremedium- to long-term growth prospects
r Boosted inter-regional trade, reducing trade dependency on the G3r Increasingly shifted from pegged to freely-floating exchange rates, using these as a furthercushion against economic shocks
r Increasingly focused on targeting inflation rather than the exchange rate as the main anchorof monetary credibilityAs a result, EM country fundamentals have improved significantly. Note that well over halfmost EM sovereign debt benchmarks are now made up of investment grade credits. In linewith this, crossover investors – that is, those investors which are not benchmarked to EM– have been increasing “off index allocations” in the EM asset class. This process began inearnest in 2002–2003, but has accelerated ever since. With EM sovereign debt having beenthe top performing fixed income sector for the last five years, it seems reasonable to expectthis secular shift in investment attitudes by crossover investors towards the EM asset class tocontinue for some time to come. In addition, EM sovereign debt is increasingly being addedto more mainstream benchmarks to create so-called “blended” benchmarks. Finally, the focuson improved liability management has not only meant extending duration, but also reductionof net issuance. As a result, in EM, we have an asset class with rising demand from a growinginvestor base of “dedicated” and “crossover” investors and declining demand – a very positivecombination for relative and total return investors.A key consideration in this is that EM markets have held up well at a time when the FederalReserve has so far (through November) tightened policy interest rates by a total of 300 bpsfrom June 2004. Note that this is in stark contrast to the performance of EM in 1994, whenEM countries were still in a much more fragile shape and were thus extremely vulnerable tosharply higher US policy interest rates.Fundamental improvement is key to this. Typically, investors think of Asia when they thinkof high current account surpluses. However, it is important to note that the last five yearshave seen a significant current account balance improvement in all three main EM areas:Emerging Asia, EMEA and Latin America. For instance, in 2003, Brazil recorded the firstcurrent account surplus for 11 years and now looks set to run a third straight year of currentaccount surpluses. In addition, with the US dollar declining from 2002 to 2004, local currencystrength in many EM countries meant a tightening of overall monetary conditions, which in turnencouraged EM central banks to pursue pro-cyclical monetary policy through lower interest
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rates to boost growth. Such policies have in turn attracted more capital inflows to EM localfixed income markets, creating a virtuous circle of portfolio inflow and central bank policyinteracting with each other. Even with an increasing number of EM central banks tighteningmonetary policy, improved inflation-fighting credibility has meant that EM local markets havenot suffered unduly. Indeed, in many cases the improved longer-term policy credibility hasmore than outweighed short-term negatives. The bottom line is that:
r EM country fundamentals have for the most part improved significantlyr EM sovereign debt has benefited from a positive combination of rising demand from agrowing investor base and reduced net supply
r EM sovereign and local debt is increasingly becoming mainstream within the benchmarkedinvestment community
r EM local debt is increasingly being accessed by non-dedicated or crossover investors giventhe perception of greater excess returns plus some degree of return diversification
r EM currencies are increasingly being traded by an increasing number of investors previouslyfocused on G10This last point ties in with the increasing shift within the global investor community towardsregarding currency as an asset class in its own right. There are three main reasons for this:
r Firstly, the old consensus view that currency returns net to zero over the long term has beenproved wrong by several major investor industry consultants (e.g. Russell, Mercer, etc.).
r Secondly, the currency overlay industry has emerged with the specific aim of managingcurrency risk as a separate and distinct asset class from the “underlying”, having proved itcan consistently generate alpha.r Thirdly, poor benchmark returns on stocks and bonds have encouraged “real money”investors to consider currency as an alternative asset class to their benchmark.
11.2 INCREASING IMPORTANCE OF EM CURRENCIESImproving fundamentals, cheap valuations, a broadening and deepening global investor baseand a more credible monetary and fiscal policy have created a very positive backdrop forinvestor flows into EM currencies. Together, all of these factors have helped to boost policycredibility and market liquidity. However, the key factor in deepening EM currency markets hasbeen the gradual shift by governments and central banks towards free-floating exchange rateswith open capital accounts. This is something we now take for granted, but it was not alwaysthe case. In some countries and regions in EM, governments have sought to hold back thetide of market forces, ostensibly for the purpose of preserving market stability. Nevertheless,the trend – at least for now – remains strongly in favour of increasing depth, liquidity andimportance of EM currency markets.The 2004 BIS survey still shows that EM currency volumes remain small by comparisonwith those in the G10. However, EM currency volumes are picking up very strongly. Moreover,they look set to grow at a much stronger pace than G10 for the foreseeable future. The viewthat EM FX is maturing as an asset class appears to be confirmed by improved liquidity,tighter bid/offer spreads in spot, forwards and options and larger volumes transacted withoutmajor market distortion. Moreover, an often-missed fact is that EM countries now make up anincreasing slice of global growth. This is particularly the case in Asia where the contributionof China, followed by Korea and India, has been increasingly supportive of global growth.
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The increasing depth of these EM currency markets has in turn attracted increasing interest inhedging and trading activity from corporations and investors. In particular, the rise in corporatehedging since 2001 has been truly explosive since 2001–2002. Asian authorities are graduallyallowing greater use of FX derivatives, firstly for the hedging of “natural” business exposuresand to varying extents for trading. EM FX options have seen rapid growth across al of threemain EM regions. In the absence of any moves by authorities to reverse recent market reforms,this growth again looks set to continue at a very rapid pace for the foreseeable future. Thereare also signs of emerging demand for FX derivative product in the likes of Africa and theMiddle East. In the first case, South African FX markets are among the deepest and mostliquid in the EM world – though they can become decidedly less so during times of marketturbulence such as we all witnessed in 2001. In the rest of Africa, local markets remain relativelyilliquid though the authorities in specific, notable cases are gradually allowing the use of FXoptions for hedging and yield enhancement. There remains strong demand for proxy hedgesin G10 currencies given the lack of liquidity in some African currencies or availability ofsuitable hedging product. Nevertheless, as African countries focus on strengthening economicperformance over the medium term – shifting away from a more political emphasis – it seemslikely that local markets will gradually open up, reducing the need for proxies. In the secondcase, most currencies in the Middle East are pegged to the US dollar. However, the prospect ofeventual currency union in the Arab Gulf should generate a significant increase in FX productavailability and liquidity.All available indicators suggest a continuation of the explosive growth in EM FX volumesand product. In line with much faster growth in EM countries, this can only suggest that EMcurrencies will continue to become increasingly important within the global FX market.
11.3 EXPLOSIVE GROWTH IN ASIAN CURRENCIESAs noted earlier, the rise in trading volumes of Asian currencies has been even moreexplosive than that of overall market volumes. Whereas global FX turnover (includingspot/forwards/swaps) rose by 57% in 2004 from 2001 at current exchange rates, and 36%at constant exchange rates, Asian currency trading volume has in several cases grown by over100%. Indeed, the total volume of CNY trading has grown by 530%, that of the IDR by 283%,the TWD by 129%, the KRW by 117% and the INR by 114%.2 Interestingly, volume in the“Aussie” and “Kiwi” dollars has grown by 96% and 163% respectively despite these countriesbeing seen as mature, developed economies. This may reflect a number of factors includinginternational investors being increasingly active in these currencies because of high yield andincreasing trade between Australia and New Zealand on the one hand and Asia on the other.Some key questions need to be asked, given these results. Firstly, what are the main factorsbehind this explosion in Asian currency volumes and will they continue? Secondly, giventhe explosive growth in Chinese yuan trading volumes, will the Chinese yuan become oneof the main traded currencies in the world, potentially at some stage over-shadowing theJapanese yen? Thirdly, with Asian countries becoming increasingly important in terms ofglobal growth and Asian currency liquidity continuing to deepen, might the link between“major” and “EM” currencies be changing; the causality becoming more two-way rather thanone-way. For instance, Asian central banks now control over three-quarters of the world’s FX2Ma, Guonan/Ho, Corrine/McCauley, Robert (2005). Trading Asian Currencies, Bank of International Settlements QuarterlyReview, March 2005, p. 50.
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reserves. This suggests an ability to impact not just their local FX markets, but also to anincreasing extent G10 FX markets. Moreover, just as Asian currency trading patterns may bebecoming more important, might the trading patterns within Asian currencies be changing inorder to reflect the increasing importance of economies such as China, South Korea and India?The explosive growth in Asian currency volumes has been due to both external and domesticfactors. On the external side, rising strategic asset allocations by non-dedicated or “cross-over”investors, and increasing focus on carry trades as policy interest rates in the “major” currencieshave declined, have boosted both volume and liquidity by broadening the investor base. Onthe domestic side, recovering economies, strengthening currencies and renewed reforms ofexchange rate and capital account regimes have also boosted investor interest. Indeed, asAsian capital accounts are being gradually opened up, Asian FX volume as a percentage ofinternational trade is starting to increase to a notable extent. Simple economics suggests thatthis should be the likely result and indeed it is happening in reality. That said, if we excludeJapan, in most cases, Asian FX volume as a percentage of trade remains very low. On theface of it, this is a potential negative. However, from another aspect, this is a huge growthopportunity. Whereas Japanese FX volume is around 100% of Japanese international trade,the same figure for many Asia ex-Japan countries is for the most part below 10%. For now,FX controls in a number of countries in Asia are inhibiting FX volume growth. However, withthe general trend towards free-floating exchange rates, it seems likely that these controls willbe gradually relaxed over time – boosting FX volume substantially.The rise in Asian FX volumes is even more spectacular in derivative markets than it is inspot. This is particularly the case with regard to Asian FX options, with Asian investors andcorporations taking advantage of new trading and hedging products to manage their risk. Inparticular, the explosion in Chinese yuan FX volumes, albeit from a very low base, is in part ofa function of the increasing importance of China’s economy to global growth. However, it isalso a function of heightened expectations for a revaluation of the Chinese yuan, which is seenby many as undervalued. On July 21, China made a first move in this regard, revaluing the yuanby some 2.1% against the US dollar, maintaining +/− 0.3% daily trading bands against thedollar, but expanding those first to +/− 1.5% against other major currencies such as the EUR,JPY and HKD and then to +/− 3%. Further moves are likely, albeit at a very cautious andgradual pace, as appropriate, relative to the needs of China’s economy. The Chinese authoritiesare also moving to create appropriate onshore hedging instruments, firstly with forwards andat some later stage with more complex derivatives. The emphasis is always on gradualism, notjust because that has been the hallmark of Chinese economic policy since Deng Xiaoping, butalso because Chinese corporations need time to adjust to increased FX risk. A crucial part ofthis process therefore entails educating the domestic Chinese corporate base in managing FXand interest rate risk. Once the hedging instruments and the knowledge are in place, acceleratedFX reforms seem likely.At the offshore level, Chinese yuan NDF volumes have also grown dramatically. In part,this is because they are the only effective offshore tool for trading the Chinese yuan at thepresent. In part, this is also because of heightened expectations for yuan revaluation. Prior tothe July 21 revaluation, there was a marked increase in the correlation between yuan NDFsand Asian regional currency spot rates, reflecting the increasing importance of China to theAsian regional economy. The Japanese yen remains the most important influence for much ofAsia, particularly for North Asia. However, China is catching up fast.As a percentage of international trade flows, yuan FX volume is among the lowest in Asia,reflecting the relatively early stage of FX reforms in China. The same is true for Malaysia,
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which pegged the ringgit to the US dollar from 1998 to July 20, 2005. Indeed, as a percentageof international trade, Hong Kong FX volumes are almost 15 times larger than those of eitherChina or Malaysia. This may be due in part to the fact that Hong Kong effectively serves asa huge trade port for Chinese “re” exports. However, it is also, and more importantly, due tothe fact that Hong Kong has a fully open capital account and fully developed FX markets withliquid trading and hedging instruments. As China opens up its capital account and develops itsmarkets onshore, FX volumes onshore as a percentage of flows are set to explode.Prior to the Asian currency crisis of 1997–1998, Asian currencies were a dollar bloc in somuch as most were actually pegged to the dollar within very tight limits, while others thatwere not actually pegged still had the dollar as the main reference and base currency. Theassumption of most people was that after the Asian currency crisis Asian currencies wouldgradually drift back to being a de facto dollar bloc once more. This has not in fact happened,largely because of the emergence of the Chinese economy and the gradual recovery of Japanhave combined to result in effective currency competition for the US dollar.As a result, and given the increasing importance of China and Japan to the rest of Asia,the relationship between Asian regional currencies and the “major” currencies appears to bechanging. Previously, this relationship was defined by a one-way causation from moves in the“major” currencies to Asian currencies. However, given the increasing importance of Asianregional economies – notably China, South Korea and India – that causation is increasinglybecoming two-way. Going forward it is entirely conceivable for moves in the USD–CNY, USD–INR and USD–KRW exchange rates to have an impact on the likes of EUR–USD, USD–JPYand GBP–USD given the importance of China, India and Korea in global manufacturing andservices. Indeed, three of the biggest currency movers, after the yuan revaluation on July 21,were the Japanese yen, the Euro and sterling. The process has already begun.Because of this changing relationship and the increasing importance of China, Asian currencies also appear to be trading increasingly on a multi-polar basis rather than just against thedollar. The days of the US dollar bloc in Asia are numbered. Instead, Asian currencies will increasingly trade on a nominal effective exchange rate (NEER) or trade-weighted basis. Indeed,it was no coincidence that on July 21 both China and Malaysia moved to NEER-based managedfloating FX regimes, de-pegging from the dollar in the process. A number of Asian centralbanks keep track of their currency on a NEER basis. Now, China, Singapore and Malaysia doso formally and they are unlikely to be the last. The rise in Asian currency volumes and thegradual shift to NEER-based exchange rates reflects the increasing importance of China andthe increasing importance of inter-regional trade.
11.4 ASIAN NDF MARKETS: GROWTH AND LIBERALIZATIONThere is an increasing focus on market liberalization although admittedly some specific countries still have a way to go in this regard. Some currencies, apart from the Chinese yuan, arestill not fully convertible on the capital account and such restrictions clearly have a materialimpact on overall FX volume. Ahead of full convertibility, we have seen the birth of the “nondeliverable forward” or “NDF” market in many EM countries, not just in Asia. An NDF issimilar to a deliverable forward. However, delivery is in US dollars; NDFs are net cash settled and the settlement amount is determined by the difference between the NDF contractedrate and the fixing rate. A crucial difference between NDFs and deliverable forwards is thatNDF rates are not typically dictated by domestic interest rates, so there can periodically be
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significant differences between where domestic rates imply that NDFs should be and theiractual levels.In the absence of suitable onshore hedging instruments, the NDF is a product that is trulythe result of client needs. Both corporations and investors use NDFs to manage their currencyrisk, while speculators also use NDFs to anticipate specific currency moves. It stands to reasonthat NDF markets have been strongest and most liquid in those currencies where investors areactive, but there are not necessarily suitable trading or hedging instruments onshore due to lackof currency convertibility. This is a key point. Speculators may on occasion use NDFs, but theNDF markets emerged due to real investor and corporate demand for suitable instruments tomanage their currency risk, given a lack of such instruments onshore. In Asia, the most activelytraded NDF markets are in the Korean won (KRW), the Taiwan dollar (TWD) and the Chineseyuan (CNY). The Philippines (PHP), Indonesia (IDR) and India (INR) also have active NDFmarkets. Asia and Latin America make up the vast majority of the more liquid NDF markets.While some may see NDFs as potentially being in conflict with local currency regulations, thetruth is that they provide an important source of liquidity in the absence of onshore instruments,helping to attract investment to that country in the absence. The real focus should of coursebe on creating a liquid and efficient onshore FX market and thereafter scrap FX controls, thuseliminating the need for an offshore NDF market.As we saw on July 21, the trend in the Asian FX market is one of continued market liberalization and increasing flexibility. In some cases, such steps towards greater market liberalizationand currency flexibility will continue to be cautious, as is only proper. Nevertheless, the trendis clear. As Asia takes on ever-increasing importance in the global economy, so its financialmarkets will need to be sufficiently liquid to match increasing requirements. In China’s case,this may well mean the development of onshore exchange rate derivatives such as forwards,swaps and options to allow domestic corporations and investors to manage their exchange raterisk appropriately. Asia is moving generally towards greater exchange rate flexibility. Nevertheless, in the near term, certain convertibility and liquidity restrictions may remain. Withliquid onshore alternatives not yet available in some cases, NDF volumes can be expected tocontinue to rise near term, as they remain the only way to manage currency risk.
11.5 EMERGING EUROPEAN CURRENCIESThe rise of Emerging European currencies is to a significant extent a function of the EUaccession process. Some 10 new countries joined the EU from May 2004 with the prospect ofjoining the Euro at some later stage. Note that the new EU entrants do not – unlike the UKor Denmark – have the option of “opting out” from the Euro. As these countries are certainto join the Euro at some stage, they are clearly drawing in significant capital. According tothe Institute of International Finance (IIF), private capital flows to Emerging Europe rose toUSD108.9 billion in 2004 from USD65.1 billion in 2004 and rose again to USD131.5 billionin 2005. The IIF expects private capital flows to Emerging Europe to slow to a still strongUSD110.8 billion in 2006. The 2005 figure represents almost 40% of all capital flows to globalemerging markets.3Prospects for capital flows into Emerging Europe continue to look bright, driven by furtherincreases in foreign direct investment and non-bank creditor flows. Proximity to Western3
Institute of International Finance (2005), Capital Flows to Emerging Market Economies, p. 7.
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European markets and still relatively low labour costs are attracting direct investment in theregion. Despite disappointing performances by several Emerging European currencies thisyear, portfolio investment has also increased sharply to the region. However, it has focused toan increasing extent on specific countries such as Poland, Turkey and Russia.The result of all this has been a significant rise in the liquidity of Emerging European FXmarkets. The Czech Republic, Hungary and Poland now have liquid and deliverable spot,forward and options markets. Slovakia is also opening up its markets. Having joined the EU,the expectation is that these 10 new members will join the Euro some time between 2008and 2012, having met the Maastricht Criteria on exchange rates, inflation, debt/GDP, budgetdeficits and inflation. The 10 new countries include The Czech Republic, Hungary, Poland,Slovakia, Slovenia, Cyprus, Malta, Latvia, Lithuania and Estonia. As such, the emergenceof growing Emerging European FX markets will eventually be overtaken by their inclusionwithin the Euro. Assuming that this does indeed go ahead, the stage will be set for other EUhopefuls such as Bulgaria, Romania, Croatia – and eventually Turkey – to make preparationsfor eventual membership of the Euro.
11.6 LATIN AMERICAN CURRENCIESLatin America as a region has typically received only around 10–15% of private sector flows toglobal emerging markets – a much smaller share than those of Emerging Europe or particularlyAsia. For instance, China receives around 25% per year more in foreign direct investment thanthe whole of Latin America combined. Of total Latin American inflows, Mexico still takes inthe lion’s share although Brazil appears to be catching up.Why does Latin America receive much smaller inward investment than either Asia or Emerging Europe? Some possible answers are a continued need for market liberalization, market andeconomic infrastructure and the efficiency of the economy through price competition. Thatsaid, the Mexican peso has around 1% of global FX turnover, a higher share than most currencies in Asia. Most Latin American currencies are not deliverable and therefore trade on anNDF basis. Mexico is the one notable exception and it is no coincidence that it has a muchhigher share of total FX turnover than other Latin American countries such as Brazil, Chileand Argentina. Clearly, Mexico’s membership of NAFTA is another important reason for itshigher FX turnover. It seems reasonable to assume, therefore, that should other Latin Americancountries be allowed to join NAFTA, they too would see sharply higher FX volumes, assumingof course that in so doing they liberalized their exchange rate regime.
11.7 SUMMARYIn this final chapter, we have looked at the “Emerging World” of currencies and the newgrowth opportunities that exist within global FX markets in the Emerging Market regions ofAsia, Emerging Europe and Latin America. It is clear that the greatest opportunities for FXmarket development lie in Asia, both because of the state of capital market development theyhave reached and also because of the size of their economies. China’s economy is now thethird largest in the world and may soon overcome that of Japan to take the second spot. India’seconomy is starting to pick up steam, thanks in large part to recent efforts to deregulate theeconomy. South Korea and Taiwan are also major economies within Asia. China and India inparticular are liberalizing their economies, opening up their capital accounts and freeing theirexchange rates, albeit in a gradual manner. With FX volume in both of those countries still a
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very small portion of trade, the potential is truly explosive as regards volume growth in theAsian FX market.There are two final points to make with regard to the increasing importance of the EmergingMarkets within the global economy and in global FX. Firstly, the emergence of the so-calledBretton Woods II system – whereby Asian central banks keep their currencies competitive byrecycling regional trade and current account surpluses back into US fixed income markets,in turn helping to keep US interest rates lower than they would otherwise be and supportingUS economic growth – shows how the global economy has changed fundamentally since theEmerging Market crises of the 1990s. The Asian economies in particular have built up hugeeconomic buffers in the form of booming FX reserves and large current account surplusesagainst future potential market volatility, having learned the painful lessons of 1997–1998. Onlya few years ago, the idea that Asia would effectively control the global economy through theirintervention activities would have been seen as laughable. Yet today, it is a reality. Those Asiancentral banks that have been particularly active interveners tend to be those where domesticdemand in their country remains weak. In turn, they also tend to be those countries where wagegrowth is low. Real Effective Exchange Rate undervaluation can be corrected through NEERcurrency appreciation or through higher inflation, or some combination thereof. With manyAsian central banks not allowing their currencies to appreciate, higher inflation is inevitablein these countries in order to restore equilibrium. Higher wage growth will play a part in that.Rising wage growth will boost domestic demand, thus reducing the burden of overall growthon the external sector. This in turn will allow Asian central banks the freedom to let theircurrencies trade more freely and appreciate if appropriate. Thus, while the Bretton Woods IIsystem – if we allow for such a concept – seems a semi-permanent feature of the global FXmarket, this system would appear to have the makings of its own downfall in a changing globaleconomy – just like its predecessor Bretton Woods I.Secondly, Asian central banks have become a new investor asset in their own right due tosoaring FX reserves. Previously, Asian central banks focused on liquidity management andFX intervention when appropriate. Increasingly, however, they are focused on FX reservemanagement for the purpose of generating a return. Indeed, many central banks now haveboth fixed income and currency-hedging benchmarks, making them seem increasingly likereal money or currency overlay investors. With well over 70% of global FX reserves, thesecentral banks are now a major force in global FX market turnover.In sum, the Emerging World is becoming increasingly interlinked with the so-called“developed” markets and as such is playing an increasingly important role in both the globaleconomy and global financial markets. With Asia opening up, this trend is likely to continuefor the foreseeable future.
ConclusionThere is no getting away from it – currency forecasting let alone hedging, investing or tradingremains a tricky business. To the uninformed, such activity represents little more than tossinga coin. If I have succeeded at all in this book, then I hope to have shown that it is significantlymore complex and sophisticated a process than that.Economic theory, despite the intellectual weight of many of the great theorists of our time,has struggled in its ability to model and successfully predict short- or medium-term currencymoves on a consistent basis. In reaction, some have taken the easy way out by relapsing intothe excuse that short-term exchange rate moves obey a random walk and therefore cannot bepredicted. To me, this is nothing more