1 Analysis‎ > ‎Economics‎ > ‎06 Currencies‎ > ‎

FOREX

The FOReign EXchange Market

Edited from Wikipedia: Foreign exchange market

About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency.

To get some idea of volume see BIS table D5

Traded Currencies - FOREX Market Share (April 2010)    

USD    ($)    84.9%    United States dollar
EUR    (€)    39.1%    Euro
JPY     (¥)    19.0%    Japanese yen
GBP    (£)    12.9%    Pound sterling
AUD    ($)      7.6%    Australian dollar
CHF    (Fr)     6.4%    Swiss franc
CAD    ($)      5.3%    Canadian dollar
HKD    ($)      2.4%    Hong Kong dollar
SEK    (kr)     2.2%    Swedish krona
NZD    ($)      1.6%    New Zealand dollar
                    18.6%    Other Currencies
Total            200%


Central banks attempt to stabilise the prices and their own currencies using their reserves etc. but there are limits as to what can be done and those actually seeking delivery of foreign currency are only left with an indirect influence on the price, based on their influence of speculators opinions. Opinions often with little more behind them than any propaganda.

Even of those seeking delivery of a foreign currency, the proportion of foreign exchange transactions stemming from cross border-trading of financial assets has dwarfed the extent of currency transactions generated from trading in goods and services. Consequently, currencies are increasingly demonstrating a strong correlation with other markets, particularly equities.

FOREX Factors

The following factors that influence the foreign exchange markets are listed in order of their impact.

News and Opinion

News has more impact then reality major changes take place as a result of news that is often blown right out of proportion. News of wars, elections, monetary policy changes and financial crises. These events have the ability to change or reshape the country, including its fundamentals leading to many self fulfilling prophecies.

Black Swan Events - Hind sight, explaining what happened after a negative event with selected supporting information that actually doesn't represent all that happened is common practice.

Economic Factors

Open Market Operations 

Central banks buy and sell their reserves to try to stabilise, control or manipulate their currency on the world market.

The Central bank can always buy foreign currency for home currency, potentially devaluing its own currency and increasing the value of the foreign currency and increasing its foreign currency reserves. (Which may be held as cash or invested i.e. China buying US treasury bonds.) It can also do the reverse, sell reserves for its own currency with the reverse effect but only to the extent that it has them though.

The central bank's monetary policies are generally directed towards;
  1. Maintaining stability of the currency meaning price stability, moderate interest rates, stable exchange rates and financial market stability.
  2. Achieving economic growth (Encouragement of savings supplies funds that can be drawn upon for investment.).
  3. Maintaining full employment, and ensuring the welfare of the people.
See The Banks

Competitive Devaluation

Countries may gain an advantage in international trade by competitively devaluing their currencies. This lowers the price of exports to the rest of the world but raises the price of imports at home.

People's Republic of China has succeeded in doing this over a long period of time. However, in a real-world situation, a 2005 appreciation of the Yuan by 22% was followed by a 38.7% increase in Chinese imports to the US.

While the west lends money to banks the Chinese have used quantitave easing to promote manufacturing for export not financial speculation and financial services. They don't let hot money come in. The state sector dominates banking. Chinese stimulus $580bn went into infrastructure.

In 2010 other nations, including Japan and Brazil, attempted to devalue their currency in the hopes of subsidising cheap exports and bolstering their ailing economies.

As a result of competitive devaluations investors are moving on mass to invest in currencies that seem least likely to devalue, i.e. because they have positive balance of payments and positive investments. This cases severe appreciation (bubbles) in these currencies and credit surpluses leading to low interest rates and debt bubbles in the economies concerned.

Balance of Payments

Because the balance of payments only reflects the 10% to 30% of real as opposed to speculative transactions on the currency market it can have less of an effect on supply and demand then might be expected.

In the U.S., the Commerce Department releases balance of trade data on a monthly basis, which shows the amount of goods and services that the U.S. exported and imported during the past month. See Balance of Payments for details.

Interest Rate Parity

The comparative interest rate (risk often ignored) leads to the carry trade where people borrow in one currency to invest in another. This shows up in the the balance of payments.

Inflation may also effect the exchange rate over time and so those investing in foreign currencies must consider this.

Foreign Investment

Foreign investment increases or decreases which includes the carry trade mentioned above can cause significant changes in the exchange rate especially when backed up or caused by a news story.

China buys US Treasury bonds with earned $ thus investing in the US Government.

Purchasing Power Parity

Purchasing power parity has a secondary effect on exchange rates when it becomes profitable to import or export things that were previously not imported or exported and so the foreign exchange transactions effect the market. This shows up in the the balance of payments.

Material Factors

Gross Domestic Product

value of all final goods and services produced within a nation in a given year.
  • private consumption,
  • government spending,
  • business spending, and
  • total net exports.
GDP is considered the best overall measure of the health of a country's economy, with GDP increases signalling economic growth. GDP can be effected by price rises and falls making it unreliable. Also sale of financial instruments etc??

Retail Sales

Retail sales reflects consumer spending. where increased spending signals a strong economy?.

Durable Goods

The data for durable goods (those with a lifespan of more than three years) measures the amount of manufactured goods that are ordered, shipped and unfilled for the time period. These goods include such things as cars and appliances, giving economists an idea of the amount of individual spending on these longer-term goods, along with an idea of the health of the factory sector. This measure again gives market participants insight into the health of the economy, with data being released around the 26th of the month by the Department of Commerce.

Employment

Increasing employment should bring new products and services to market and also new money as wages and profits. The effects on the economy will depend on whether money or products and services are removed from the market. Usually foreign investors will remove money while exports will remove products and services. The removal of money will lead to price decreases while the removal of products and services will lead to price increases.

Links

An excellent source of info is FT Video
  • http://video.ft.com/v/1054742424001/Can-US-politicians-reach-a-debt-deal-

The War on the Euro

Yes there are traders conspiring to profit from damage to economies. Attacking Greece

Tax the Banks

Tax the banks and stop the speculative damage.

YouTube Video



Tax on Forex in the UK

This section has nothing to do with the above. This is about Personal Tax paid by traders. The above is a discussion about a bank transaction tax.

The best I could find on the subject was;

http://www.traderstaxclub.co.uk/public/141.cfm?sd=2

Which stated:

As you're no doubt aware there are two broad options for being taxed on your forex profits. You could either be a forex trader or a forex investor.

The two are completely different in tax terms (its essentially the same difference as between a property investor who purchases property to rent or a property developer who purchases property to renovate and sell).

Forex traders are subject to income tax. Potentially at 40% and even 50% after April 2010 if they have profits over £150K. Investors are subject to CGT and the 18% CGT rate.They'll also have the annual CGT exemption of around £10K to offset. Traders have a wider expense/deduction offset are classed as self employed. This means if they had no other income they'd also need to account for national insurance (class 2 at around £2.00 per week) and class 4 at 8% on profits above the primary threshold).

So essentially if you're a basic rate tax payer its the difference between 18% CGT and 28% income tax and NIC. If you're a higher rate taxpayer the rate difference is 40% v 18%. There's also the allowances/expenses etc to take into account.

For many, trader status would not be advantageous, at least not unless there were losses, so avoiding being taxed as a forex trader would be advisable.

Establishing when you are and aren't a forex trader is not straightforward though. In particular one of the questions we're frequently asked is whether if forex income is your only income this will make you a trader?

Just because it's you only 'income' would not automatically make it trading income. The whole nature of your activity would need to be assessed. The general rule with forex activities just as shares, derivatives and other financial assets is that you are an investor. There would need to be an organised trading operation before you'd be classed as a trader. In the case of an individual (ie not a company) this is more difficult to apply.

Given that under self assessment it is for you to self assess your own tax liability you should determine the status of your forex activity. In most cases completing the return on the basis of a forex investor would also be accepted by HMRC.

The fact that the forex income is your only income would not therefore mean anything by itself. You could for instance have no other income but earn generous profits from a minimal number of trades per week and essentially be 'lucky' with your investments.

By contrast you could have another occupation, trade frequently with sophisticated risk management and a commercial set up and have a better chance of being classed as a trader.

Also HMRCs veiw on exchange rates can be useful;

http://www.hmrc.gov.uk/exrate/


© Tom de Havas 2011. The information under this section is my own work other than where indicated, it may be reproduced without modification but must include this notice.




Subpages (1): Price Parity
Comments