Sunday, December 27, 2020

Anatomy of an FX Transaction — NeilW


I have been waiting for this. Thanks, Neil!

New Wayland
Anatomy of an FX Transaction
NeilW

23 comments:

Ramanan said...

A good reference is:

"What is the Accommodating Item in the Balance of Payments?" by David Chaundy:

https://www.cbr.cam.ac.uk/fileadmin/user_upload/centre-for-business-research/downloads/working-papers/wp122.pdf

Tom Hickey said...

Thanks.

Marian Ruccius said...

Thanks.

Matt Franko said...

“Somebody within the net exporter currency area has to end up as the saver of FX financial assets, and they are forced to be that entity or the currency rates will move to match the flow with the available quantity of savers. “

This is equivalent to “banks lend out the deposits!”... the foreign currency can be an asset of the intl banks which I wouldn’t exactly call “savings” of the banks,,, it’s just a risk asset of the bank like any other that can be assigned a price in the reporting currency terms..

The currency exchange rate wouldn’t move unless the exporter changed the price from that which it previously accepted for oil... as any existing loans the foreign country bank was doing to inventory oil would be worth LESS in EUR terms as collateral value of the loans would be falling in EUR terms if US producers started to accept less EUR for a bbl of oil...

All the currency exchange rates reflect is the relative financial terms of trade between the two nations.... iow if you go back to the glory days of opec, if US importers started to pay more USD for a bbl of oil the USD would go down .... oil used to be $155 imported then EUR was $1.60...

You can’t separate the bank regulatory effect of changes in the prices that real producers sell their real product for across borders from the purely financial accounting results that follow from that ... which is the exchange rate..

USD has been weak under covid as EZ shutdowns are causing shortages in EZ sourced product so us importers are probably agreeing to pay more in EUR terms for limited availability EZ sourced product... if this current trend where US getting no fiscal compensation and instead frantically trying to get open while EZ stays shutdown and is getting good fiscal compensation stays the same it’s going to be continued bearish USD ...

I buy Vice golf balls from Germany (was $1.10 per ball all in) they are completely SOLD OUT and not available... I have a vendor that reps a EZ sourced equipment line he can’t get any at any price right now.. he is only able to sell his US and Japan sourced product lines.. there is a supply shock currently for foreign sourced product in US.. bearish USD...

US is probably dumping oil and oil product into EZ right now to just get rid of it... lowering price in EUR terms to move it... bearish USD...

The exchange rate is a regulatory accounting result...

sths said...

Can we please get a Matt vs Neil showdown to hash out on things like fx and bank regulatory changes on their lending capacity. I reckon we'd get more views than mcgregor vs khabib.

Greg said...

Thanks for the post Neil

This;

“The choice, however, rests with the exporting nation - since they can bring their currency down by market intervention without limit. A smart importing nation would realise that and manage its relationships so that economic and political pressure in the export nation is brought to bear - rather than trying to buy foreign savers with needless interest payments. An approach that just exacerbates the problem rather than alleviates it - since the interest payment really needs to be saved.”

I would love a little more fleshing out of this comment. What would be an example of “managing relationships so economic and political pressure is brought to bear”? Also, does “rather than trying to buy foreign savers with needless interest payments” mean allowing foreign entities to hold interest bearing Treasuries ? Finally, who is doing the saving of the interest payment you refer to? Do you mean if we allowed no holding of interest bearing bonds we would be saved from paying interest or that the recipients of the interest need to save that interest flow? Sorry for the barrage but that was a meaty ending to the post

Matt Franko said...

I need a whiteboard..,

Matt Franko said...

sths,

All you need to know is what Warren sez: “ALL prices are necessarily a function of what govt pays for things or what they let their banks lend against things...”

Including the price of foreign currencies..,,

That is all you really need to know..,,

Matt Franko said...

“or the currency rates will move to match the flow with the available quantity of savers. “

This is straight “Quantity Theory of Money!”... 100% Monetarist...

Matt Franko said...

https://www.federalreserve.gov/monetarypolicy/bst_liquidityswaps.htm

“ When a foreign central bank draws on its swap line with the Federal Reserve, the foreign central bank sells a specified amount of its currency to the Federal Reserve in exchange for dollars at the prevailing market exchange rate. The Federal Reserve holds the foreign currency in an account at the foreign central bank. The dollars that the Federal Reserve provides are deposited in an account that the foreign central bank maintains at the Federal Reserve Bank of New York.“

What?... don’t tell me now the “exchange rate vigilantes!” could put a stop to this....

NeilW said...

"the foreign currency can be an asset of the intl banks which I wouldn’t exactly call “savings” of the banks"

That's exactly what it is. It's a Nostro deposit at the correspondent bank in the other currency area. Which is fiscal saving in aggregate.

The bank is the 'saver' - by choice since it is the one that decided to take on the task of financing the inter-currency area exchange.

If the banks don't want to play at saver than transactions that would otherwise have happened fail to happen - which shifts the supply and demand in the currency marketplace.

The smaller the currency, the more the matters.

Greg said...

Neil

Regarding the currency marketplace, it’s not the same marketplace that say I was dabbling in a few years ago when I had an OANDA acct and simply speculated on moves in relative currency values right? While those prices may move in parallel directions and probably have the same relative values ( dollar stronger than euro in both markets say but maybe not exact same relative value) the banks operate on a different market price I suspect.

Greg said...

Btw sths

I’m betting on Neil to win that showdown. Franko only has half a Masters.

NeilW said...

" it’s not the same marketplace that say I was dabbling in a few years ago when I had an OANDA acct "

No. The retail market is largely irrelevant - since the bank generally takes the other side of the deal in the aggregate knowledge that most retail currency speculators are zombified idiots. (Subscribers to Mike's MMT Trader newsletter being the exception).

It's the bank to bank market where the price is determined.

Good review of the FX market structure from the BIS here

Greg said...

Thanks Neil

I suspected as much but I’d never seen anything about pricing on interbank markets.

So when you see the financial channels quote changes in currency markets, usually breathlessly describing a plummeting dollar when they want to raise inflation fears or snidely pointing to a crashing euro when they want to demonize those socialist Europeans, are these more closely related to the interbank prices or more the retail market?

I suspect that there are times when WE are told the dollar is stronger than the Euro say but in actuality, at the level you are examining here, the dollar holders or dollar users are actually paying a higher price. Is that so? Does it sometimes even differ say based on exactly what is being bought? You described an oil transaction between Norway and GBR but if the transaction were for something else like fish oil or vodka it is quite probable that the exchange rate would be different... right?

What this all seems to expose , to me, is that any effort to boil down our complex trade interactions and come up with A currency strength is just a fools errand. Trying to distill it down to a number which represents your countries currency strength is just more chest puffing and not tied to the real economic activity of the day. It’s about swaying peoples emotion and getting movements in these “play markets” like OANDA or bond markets, since everyone is convinced that strength of currency>> inflation changes>>> bond prices.

Matt Franko said...

“If the banks don't want to play at saver“

They don’t “play savers!” that’s figurative language... they have foreign offices that are regulated by the foreign governments and make loans in the foreign currencies... to do that you need to have Tier1 assets in the foreign currency which includes EUR Reserve Assets...

Then the bank is primarily regulated by the nation it’s domicile in and has to report in that currency unit...

US banks (depositories) have over $2T in USD Reserve Assets right now and almost 4T in UST Securities because they are regulated ... they are not “saving the money!” to “lend out!”... if their foreign offices have foreign reserves it’s for the same reason...

Intl banks have foreign currency denominated reserve assets which they can assign differing conversion rates to in their domestic/reporting currency terms to maintain compliance with regulations in the varying real business conditions.. this is why currency exchange rates vary over time...

It’s not because “banks don’t want to save!” ... it’s because banks want lo create loans and maintain compliance...

You’re doing Monetarism if you think otherwise...

Greg said...

Seems to me you are putting a few words in Neils mouth there Matt. He never said they are saving the money “to lend out”, he just said they are saving. Probably could have said holding, or keeping in an account, probably due to some interbank regulation. In this context saving simply means money that can’t be promised to settle some other transaction. If you aren’t spending you are saving, even if for a night.

This might not be much different than when I go to trade on some markets, OANDA for example, I have to put some money into an account in order to make transactions. I have to open an OANDA savings account so that I can settle my trades on OANDA. Many markets want you to put up the capital first that you are going to use for trading, they won’t allow you to used borrowed funds and some require end of day settlements

Matt Franko said...

“ I can settle my trades on OANDA. “

et tu Greg...

6 months ago you were a fiery 30 something legit sjw who would have never even thought of doing some forex speculation...

Greg said...

Haven’t been 30 something since the 90s

Matt Franko said...

Well not in my mind... :p

Peter Pan said...

How old do you think I am, Matt?

Calgacus said...

Matt is of course wrong. Believing that fx prices are NOT set in Bizzarro World auctions where the auctioneer raises prices to get buyers to come back - isn't monetarism, but the most indisputable observation of the economic behavior of humans, or even any living thing.

If you think to be more scientific by using unusual words, randomly dismissing ordinary or perfectly scientific language as "figurative", isolating scientific thought etc. You end up only deceiving and confusing yourself. This is well expressed in the first paragraph of Fritz Zwicky's Morphological Astronomy, may have posted it here before, don't remember, but still worth re-hearing:

"Man has a great tendency to get lost or to hide, as the case may be, in a jungle of details and in unnecessary complications. Why do anything simply if you can do it complicated? And still, life itself presents a sufficient number of problems to keep us busy. There would seem to be no need to create additional difficulties, just for the fun of it, especially if these self-made difficulties become practically insuperable and if in the end they cause much unhappiness."

Well, maybe Matt is right after all. I could have sworn that in my world that book was entitled Morphological Cosmology, but that's not what my copy says. Maybe I drifted into the Bizzarro World last night.

Greg said...

I’m not sure we will ever really fix any of this stuff until we lose the whole concept of currency value. The dollar is how we measure value so how should we even conceive of a changing value of that with which we assign value?