The only court these days where central bankers can be held accountable for their misdeeds is in the court of public opinion. Every central banker is guilty of price fixing in one way or another, and the ramifications of their actions can be felt far and wide, especially in the wallets of we lowly consumers. Yet, even when billions of dollars are the consequence, as was the case when Swiss banking authorities abruptly lifted their 1.20-peg to the euro, global prosecutors sit idly by on their hands, ignoring the massacre before their eyes and preferring to go after less onerous crimes and misdemeanors.
Part of the natural grieving process is to reach the anger stage, right after acceptance and denial have held sway. Retail forex traders should be angry right about now. For some reason, Thomas Jordan, the chairman of the Swiss National Bank (SNB) and ringleader of the assault on the forex industry, has remained free for days, far from the handcuffs that should be chafing his wrists. As they say, he must have friends in high places, surely now amongst the export trade in his country. Removing the peg was a boon for this sector, but a bust for Swiss consumers and forex traders, just the same.
Forex brokers were hit the hardest and the quickest
For the foreign exchange industry, however, the carnage caused by the Swiss u-turn has been felt far and wide. This “black swan event” is the third in as many years that the forex industry has had to absorb, and none were directly due to misgivings in the trade. In 2013, we had Cyprus, where forex brokers went down and client funds were seized because the two major banks on the island got way too deep into worthless Greek bonds. In 2014, the Russian Ruble plummeted, but Putin’s gambit in the Ukraine, followed by heavy trade sanctions and falling oil prices, was the root cause, not poor forex controls. Lastly, the Swiss Franc Debacle resulted over the heavy screaming of a few exporters that were crying foul over a peg that never should have been created.
Yet, in each case, the forex industry has had to take it on the chin, get up off the floor, dust itself off, and charge back by rebuilding its image and restoring the confidence of its broad and global customer base. In that vein, most every brokerage house, to their credit, has declared that they will not try to recoup losses sustained by their clients. Stop-loss controls did not work properly during the chaos. If there is a place where greed holds sway, then it is with liquidity providers, the large banks in the system, which are forcing re-quotes on a number of contracts to protect their collective behinds.
Independent and bank-owned brokerage houses were hit the hardest at first report, but then the reporting coverage moved on to managed funds and those notorious risk takers, the highly leveraged currency hedge funds. The losses of FXCM (NYSE:FXCM) ($300 million) and of Citicorp and Deutsche Bank (NYSE:DB) (purported to be $150 million each) paled in comparison to the collapse of the Everest Capital Global Fund, which had over $830 million under management. The true extent of the damage, however, may never be known, and the impact on the Swiss economy is yet to be determined.
Is it all bad news on the retail currency trading front?
Reporters that attempt to write about the forex arena often state that there is always a winner on one side of a forex trade and a loser on the other end, since a pair of currencies by nature involves two different parties with disparate interests. This over-simplification runs counter to conventional wisdom taught in elementary economics that a market balances competitive forces such that each party to an exchange is satisfied. There undoubtedly will be stories of a few individuals that made out like bandits when the Swiss franc surged, but this black swan event concentrated the losses amongst a few players, namely brokers that permitted highly-leveraged and automated trades to blast through unduly low margin requirements.
It has also been reported that retail positions for the “EUR/CHF” pair were typically 90% long on the CHF side, but, due to expected changes in the market, this balance had shifted to 50%. If that were the case, would not brokers have broken even? Not necessarily! It appears that the elephant in the room is the liquidity provider. They are the ones that soaked up the profits that were had. This fact may also be the reason that you do not hear Citicorp moaning and groaning over their retail client trading losses. To date, they have not disclosed how much money they made on the liquidity supply side. We would estimate that the gains were well in excess of the $150 million of retail losses.
What else is out there to worry about in the forex world?
Central bankers have already been warning for a while of more liquidity crunches to come. Near-zero interest rates have brought about a chase for higher global returns that can only result in disaster at some point. The Fed is scheduled to raise interest rates during the second quarter. The ECB and BOY are set for more quantitative easing. These attempts to corral market forces are tempting the Fates, as well. At some point, the market will bust out of these artificial restraints. The only question is when, and you may forget about jailing the banksters. They rule by fiat.
For now, follow the advice of Bette Davis: Fasten your seatbelts, its going to be a bumpy night!