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Currency fluctuation questions from readers answered Add to ...

Question from Dean: Are many currency fluctuations caused by traders trying to make a fast buck? Is this legit? Is it socially necessary?

Michael Elliott - managing director, head of corporate and commercial foreign exchange sales, HSBC Bank Canada: The global foreign exchange market trades an estimated $4 trillion in daily volume. While there are high frequency trading accounts involved in the foreign exchange market, it is unlikely that they could consistently manipulate a market of this size. Both speculative and hedging activity are required to make the market efficient. Without the depth provided by speculative activity, it would be extremely difficult for the hedging flows to be executed without significant market disruption.

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Jean-François Lamoureux - research analyst, Export Development Canada: Freely-traded currencies like the Canadian dollar, Euro, British pound and Japanese yen are essentially commodities. Like for any other commodities (oil, wheat, lumber, gold), daily trading volumes for freely-traded currencies are significant (in fact, the global foreign exchange market is known to be world's largest financial market with over USD 3 trillion of turnover per business day). And like for any other commodities, the majority of the trading activity that takes place for freely-traded currencies originates from traders "trying to make a fast buck" as you indicate.

This trading activity is legal in Canada and in other industrialized countries. Because the majority of trading volumes for freely-traded currencies stems from speculation, it is true that foreign exchange traders collectively detain the power to move an exchange rate in the direction that they want. No central bank in the world has the currency reserves to match the foreign exchange market's depth (which is why the Central banks of countries that have a freely-floating currency rarely try, these days, to intervene in currency markets)! But foreign exchange traders ultimately take their cue from hard economic data. In other words, the "fundamentals", such as economic growth, inflation, current and capital account balances, fiscal situation, interest rates and terms of trade (the value of a country's exports relative to its imports), all guide the direction of exchange rates for freely-traded currencies.

Fixing the exchange rate at a socially or economically desirable level can potentially be the right choice for small economies where executing an independent monetary policy is difficult. Fixed exchange rate regimes are, however, difficult to maintain over long periods of time and can lead to turmoil when they are abruptly ended (e.g. Thailand in 1997). For most large economies, including Canada, having a freely-floating currency carries many more advantages than disadvantages.

Brendan McGrath - Brendan McGrath - manager, Treasury Solutions, Custom House, a Western Union Company: While the majority of flows in foreign exchange markets are speculative in nature, the incredible size of the market makes it difficult for one trader or a group of traders to move the market in a meaningful direction for personal gain. Global foreign exchange market turnover is around $4 trillion per day on average, which is about three times the average monthly dollar volume traded on the New York Stock Exchange. It would take someone with incredibly deep pockets to influence this market, and as such there is no insider trading in currencies. There are also major players in currency markets, such as central banks, whose mandate it is to stabilize their country's currency rather than speculate to make money. Take Japan for example, a country so dependent on exports that their central bank has trillions of yen at their disposal as a defense against their currency getting too strong. There is no single trader in the world that would be able to stand up against a market moving force like a central bank. As far as fluctuations in currency markets are concerned, there are many different forces at play. The ebb and flow between businesses and institutions that need to buy and sell currencies for business needs will cause fluctuations in currencies. Speculators also have a big effect on movements, although the liquidity they add to the market makes it the most efficient financial market on earth. From a social standpoint, it can be argued that due to this fact speculators are good for the markets in that they make it function better.

Question from Joanne: How should a small business hedge against currency fluctuations? What is the most cost-effective way?

Michael Elliott: There is a spectrum of available hedging alternatives available to small businesses. The "ideal" hedge will vary based on the company's risk tolerance and sophistication, the level to be protected, and the amount the client wishes to spend. You should consult with your bank for a strategy that best suits your needs. Companies should try to match exposures in both the balance sheet and the income statement, to try to offset foreign assets and liabilities - or revenues and costs where possible. The following hedging strategies could be considered:

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