The Current Crisis as a Case Study of Forex Market Dynamics
by Nicholas Adams Judge
Few events in the forex market are even currently registering with traders in the face of the biggest news to hit the international financial industry in years: The announcement of the US federal government’s intention to finally deal with the crisis in the financial industry systemically, abandoning its case-by-case strategy.
As predicted in this blog late last week, the dollar has held up rather well for the week, given initial hit on Monday following the bankruptcy of Lehman Brothers. As the realization of the massive budget defecit the US is about to take on dawns on investors, however, look for the USD to lose significant ground against the euro.
Today, though, the USD has made up much of its losses from earlier this week. As news spread of the federal government’s intentions, the dollar registered its largest jump against the Yen since April. Currently it has climbed, 2.26% against the yen, and an astounding 4.49% against the Aussie.
The lessons of the week for forex traders are fundamentally important. At each major evolution in this still-developing story, the federal government has, to the extent that political and economic liabilities have allowed it, acted as though Goldman Sachs or Morgan Stanley actually were the US economy. Over the past several years, vitally important segments of the US economy – the auto industry and housing come to mind – have been allowed to drift into disrepair, pulling the whole economy down with them. However, if one were to plot the short term interests of a Goldman Sachs or Morgan Stanley, it would almost be a perfect representation of how the government has reacted throughout this long crisis.
It is almost as if the CEO of Sachs was running the US Department of Treasury. Of course, Henry Paulson, the ex-CEO of the Goldman Sachs, actually is running the department. Little wonder, then, of the outcome.
When examining nation-states, companies, political parties or any other units of analysis important to the Forex market – or any other market – analysts and social scientists often unconsciously slip into what are called “single actor” and “rational actor” assumptions. Indeed, whole schools of political science and economics are explicitly based on theoretical models that predict actions of units of analysis based on assumptions that those units (1) are aware of their rationally-defined self-interests, and (2) act accordingly.
It’s an intuitive way to think. And when building theoretical models for academic papers, it offers two huge advantages: Ease of construction, and a huge increase in the science-iness of your academic model (even if your model isn’t backed up by empirical evidence, it certainly looks like an actual scientist created it).
It works well for academics that never throw their own money on the line, and sucker in less-learned traders. The reality, of course, is that nations, companies or any other large organizations don’t govern themselves. Leaders are selected by the organizations. Usually, that process of selection will reflect internal power dynamics within that organization as much – if not more – than the rational self-interest of the organization itself.
Hence the past week. The end conclusion of which is simply truly horrifying in terms of the long-term growth and well-being of this country. The federal government will ultimately lose hundreds of billions of dollars – perhaps more than a trillion dollars in terms of the long term opportunity cost of the whole situation. A complete reworking of the country’s wasteful healthcare system, a revitalization of our aged and aging transportation infrastructure, or a number of other improvements which would have spurred tremendous growth could have been accomplished with that money.
Rational self-interest, however, was no where close to a critical factor in the actions of the federal government, throughout this crisis. The short-term interests of the political economic elites currently in charge of the country, however, perfectly predicted how events would play themselves out. Forex traders that look to the latter usually make a lot of money. Those that assume otherwise usually get blindsided by events.
Tags: usd
About the Author - Nicholas Adams Judge
Nicholas Adams Judge is an editor and analyst for OnlineForexTrading.com. He is a Phd student at the Political Science Department at the University of Wisconsin - Madison. His research interests include political economy, statistical methods and American politics.
