PART 5: SPECIAL TOPICS
they expect it to depreciate, and they buy if they expect it to appreciate. Some speculators, such as George
Soros, have become famous for the enormous profits (or losses) they have earned by taking large positions in
certain currencies. When external pressures force a country with a pegged currency to devalue its currency,
speculators often take the blame. Whether or not they deserve blame for causing, accelerating or exacerbating
currency crises, speculators can play a useful economic role by taking the opposite side of a transaction from
that of hedgers. Speculators help make the foreign currency market more liquid and more efficient.
As in all financial markets, dealers play a crucial role in the foreign exchange business. Most foreign
currency trades go through large international banks in the leading financial centres around the globe.
These banks provide a means for buyers and sellers to come together, and as their reward they earn a
small fee, the bid–ask spread, on each transaction they facilitate. The ask price is the price at which a
currency dealer is willing to sell foreign currency, and the bid price is the price at which the dealer is
willing to buy currency. Because the ask price is slightly higher than the bid (hence the term ‘bid–ask
spread’), dealers make a small profit each time they buy or sell currency.
Finally, governments intervene in financial markets to put upward or downward pressure on currencies
as circumstances dictate. Governments that attempt to maintain a fixed exchange rate must generally
intervene more frequently than those that intervene only in times of crisis. As this chapter’s ‘What
companies do’ feature illustrates, currency movements create winners and losers, not only across national
boundaries but also within a given country. For example, a rise in the value of the Australian dollar makes
Australian exports more expensive and foreign imports cheaper. Remember, an exchange rate is simply a
price, the price of trading one currency for another. Although the financial press dramatises changes in
exchange rates by attaching adjectives such as strong or weak to a given currency, this practice is rather
odd when you recognise that they are just talking about a price. For instance, if the price of apples rises
and the price of bananas falls, we do not refer to apples as being strong and bananas as being weak! If
the price of apples is high, that is good for apple producers and bad for apple consumers. In the same
way, a rise in the value of a particular currency benefits some and harms others. Therefore, at least for
the major, free-floating currencies, governments are reluctant to intervene, because doing so does not
unambiguously improve welfare across the board.
Even when governments want to intervene in currency markets, intervention is complicated by the
fact that currency values are not set in a vacuum, but are linked to other economic variables such as
interest rates and inflation.17-1d NATURAL EXCHANGE RATE RISK HEDGES
One way to mitigate the impact that currency market volatility has on profitability is to hedge this
exchange rate risk. This can be done with a currency hedge trading strategy, or by using a natural hedge.
For example, if a company can match its revenues and expenses, or its assets and liabilities in the same
currency, this can reduce its exchange rate exposure, creating a natural hedge.
One way to match revenue and expense currency exposure is to set up production in the country
that the company is hoping to supply to. This way, much of their cost base (for example, labour) will be
denominated in the same currency as revenues. One way to match assets and liability currency exposure
would be to issue foreign-denominated debt in the country where it will be investing in assets (such as
production facilities). Figure 17.4 shows the value of corporate bonds issued, as a percentage of GDP,
for a number of countries. Compared to their international peers, Australian companies appear to be less
prolific at issuing bonds, (with bond issues worth less than 1% of GDP). Australian companies appear
to favour issuing bonds offshore, with the proportion of debt denominated as non-Australian dollar debt