Globalisation, gambling and greed Stabroek News January 14, 2001 Leading edge Last week we started a discussion about the tremendous explosion of cross-border financial flows, which characterise globalisation today. With daily movements of the size of US$1.6 trillion, financial transactions far outweigh all other transactions on earth. No wonder many see finance as the leading edge of globalisation. As I pointed out last week, three primary factors lie behind this development. These are (1) the new information and communications technology, (2) the rapid innovation of new financial instruments and services in the market place and (3) the liberalisation of financial markets in almost every country on earth. There is much debate in the literature as to which of these is the most important. I believe that that is a wasteful exercise. Clearly, without the contribution of each, the financial revolution could not have advanced at the rapid pace it has. Without the available technology, the mass of information that accompanies these transactions could not have been moved. Without new financial products to entice new buyers, the growth of sales would not have been as fast as it has been. And, without government permission, none of this could have happened in the first place. Today across all global time zones there are major financial markets, so that for 24 hours a day one or more of these is open. Some countries, like the United States, want to go a step further. Dealers are calling for their individual exchanges e.g., New York Exchange, to open on a 24-hour basis. Casino Remarkably, less than ten per cent of the US$1.6 trillion that moves in and out of financial instruments each day is connected to trade in goods and services. Over 90 per cent is the pure buying and selling of financial instruments in order to speculate about their future prices. Lord Keynes once likened the Stock Exchange to a casino-a place where pure gambling dominates. The reason for this is that on a Stock Exchange, the buying and selling of existing stocks far exceed the raising of new capital. Many persons are led to believe that the primary purpose of a stock exchange is to allow firms to raise capital for their businesses. In reality, however, "new issues" of stocks and shares, as they are called, have become incidental to the main activity of buying and selling existing stocks and shares for profit. As a result, share prices vary widely within a single day. And, since we know that from a national standpoint, the economic worth of a company, cannot vary that widely on a day-to-day basis, we can rest assured that the "true" economic value of a company is not always reflected in the momentary price of that company's shares on the stock market. Currency markets Alongside this stock exchange activity there is the currency market. Here also, funds move in and out of currencies with the same speculative intent. Why does this take place? Two considerations are at the heart of this phenomenon. First, with liberalisation, de-regulation and the integration of global financial markets, funds can move without impediment from one financial market to another in search of better returns. What is the result of this? Let us take an example. If the interest rate or return on a financial security is higher in say London than New York, then persons who have funds in New York (and these persons may be located anywhere in the world, including Guyana) would be inclined to move their funds from New York to London. Of course, they would only do so if the interest rate differential between New York and London exceeds any transactions costs they may have to pay in order to switch funds from New York to London. Let us assume that this is the case, that is, the interest rate difference is greater than the transactions costs. What then limits the amount of funds transferred from New York to London? The answer here is straightforward. As you move funds from New York to London you move out of US dollars and into British pounds. In effect you move from one national currency into another. As you do so, you take a risk. You will only make a profit if after having put your funds in London, when you are ready to bring them back to New York, the British pound does not depreciate! What would happen if it depreciates? The answer is that you will have to pay more for the US dollar than when you sold them to buy British securities. Instead of making a profit you may end up making a loss! Hot money This simple example reveals why so much funds move between financial markets on a daily basis. Persons and institutions gamble over what they expect future exchange rates of currencies will be and compare these to the interest rate differential in different financial centres. The gamble of course can become very more complicated. For a start, your actions, as well as those of countless other persons doing the same thing every minute of the day affects the exchange rate. Typically also, the interest rate is controlled by the Central Bank or some other monetary authority in a country. What they will do, and when they will do it, is very uncertain. This uncertainty adds to the risk that you take in moving funds from one financial market to another. The trillions of dollars of such funds are called "hot-money". These are funds where risks are taken by individuals, firms, institutions, and governments as they move their funds from one financial centre to another in search of a better return. Because of their volume, very small differences in buying and selling rates can earn millions of dollars. After all, one-tenth of one per cent of a trillion dollars is a billion dollars! This is a lot of money. Not surprisingly, it stimulates a lot of gambling and greed. 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