tag:theconversation.com,2011:/us/topics/currency-trading-33476/articlesCurrency trading – The Conversation2020-08-24T12:46:40Ztag:theconversation.com,2011:article/1448872020-08-24T12:46:40Z2020-08-24T12:46:40ZThe weak dollar: why it won’t be replaced as global reserve currency<figure><img src="https://images.theconversation.com/files/354140/original/file-20200821-14-1pn7xn2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Busted Benjamin. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/us-hundred-dollar-bill-beaten-ben-134970227">Bruce Rolff</a></span></figcaption></figure><p>Stock markets have been very strange this year. We witnessed the <a href="https://www.cnbc.com/2020/03/23/this-was-the-fastest-30percent-stock-market-decline-ever.html">fastest sell-off</a> in history between February and March, with the S&P 500 falling more than 30%, only to enjoy the best recovery ever, reaching an <a href="https://www.cbsnews.com/news/stock-market-sp500-all-time-high-2020-08-18/">all-time high</a> on August 21. </p>
<p>Institutional investors and especially pension funds have gone from panicking to completely reconsidering their long-term asset allocations. What we thought would be the biggest stock market crash in history has led to a fundamental reconsideration of the key risks around financial investments.</p>
<p>For international investors in general, currency risk – above all the weakening of the US dollar – has become the most important financial risk of the year. In spite of the pandemic, it has even overshadowed their considerations about specific firms and sectors. </p>
<p>For a European investor, for example, US markets <a href="https://lipperalpha.refinitiv.com/2020/08/sp-500-17q1-earnings-dashboard/">have yielded</a> about 5% in US dollar terms) in the first eight months of 2020. Translated back into euros, however, that return is 0.5% because of the <a href="https://uk.tradingview.com/symbols/USDEUR/?exchange=FX_IDC">depreciation of</a> the US dollar over the past two months. </p>
<p><strong>US dollar vs euro</strong></p>
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<a href="https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph of US dollar vs euro" src="https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=308&fit=crop&dpr=1 600w, https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=308&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=308&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=387&fit=crop&dpr=1 754w, https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=387&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/354089/original/file-20200821-22-zy72er.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=387&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://uk.tradingview.com/symbols/USDEUR/?exchange=FX_IDC">Trading View</a></span>
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<p>Some commentators have <a href="https://www.livemint.com/market/stock-market-news/is-us-dollar-s-reign-as-world-s-reserve-currency-is-under-threat-11596175872376.html">even been wondering</a> whether the US dollar might be in danger of losing its privileged place as world reserve currency. Thanks to this status, the dollar is used in most international financial transactions. This gives the US certain economic advantages, such as being able to borrow cheaply and having more leeway with its national balance sheet.</p>
<h2>Why so soft?</h2>
<p>For the dollar, 2020 has been the perfect storm. The pandemic has taken a particularly heavy toll on America. The sudden stop of the economy resulted in a massive drop in consumption and production, disrupting global supply chains and affecting commodity prices worldwide. </p>
<p>The Baltic Dry Index, often used as a <a href="https://finanzmarktwelt.de/baltic-dry-index-sub-faellt-von-5-000-auf-21-coronavirus-stoppt-den-welthandel-155825/">measure of</a> global trade and economic activity, fell 6% between January and May. This meant that <a href="https://tradingeconomics.com/commodity/crb">the prices</a> of many commodities <a href="https://www.worldbank.org/en/news/press-release/2020/04/23/most-commodity-prices-to-drop-in-2020-as-coronavirus-depresses-demand-and-disrupts-supply">have fallen as well</a>, as can be seen in the CRB Commodities Index below. </p>
<p><strong>Global commodities 2019-20</strong></p>
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<a href="https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="CRB Commodities Index" src="https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=333&fit=crop&dpr=1 600w, https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=333&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=333&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=419&fit=crop&dpr=1 754w, https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=419&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/354131/original/file-20200821-14-11sbw74.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=419&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">The Commodities Research Bureau Index reflects the overall value of 19 world commodities, including gold, aluminium, hogs, coffee and cocoa.</span>
<span class="attribution"><a class="source" href="https://tradingeconomics.com/commodity/crb">Trading Economics/CRB</a></span>
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<p>For example, the World Bank <a href="https://www.worldbank.org/en/news/feature/2020/04/23/coronavirus-shakes-commodity-markets">expects oil demand</a> to have fallen by an unprecedented 9.3 million barrels a day in 2020 from the 2019 level of 100 million barrels per day. Because oil and many other commodities are priced in dollars, weaker demand has meant a drop in demand for dollars too. </p>
<p>On top of this, the health crisis caused by COVID-19 was not confronted properly by the US authorities, so the country recorded the <a href="https://coronavirus.jhu.edu/data/mortality">fifth highest</a> death rate after Peru, Spain, Chile and Brazil. This has eroded consumer confidence and extended the prospect of a severe recession, with recovery delayed until 2022. The OECD estimates that, at best, the <a href="https://www.oecd.org/economic-outlook/">US economy will contract</a> by 7.3% (and 8.5% if there is a second wave of pandemic).</p>
<p>Finally, the US dollar has been penalised by the presidential election. Financial markets like stability, so the prospects of a change in the presidency make the recovery more uncertain. Historically, volatility in the stock market rises in the months leading up to an election (albeit less so <a href="https://www.cnbc.com/2020/05/07/heres-how-dow-sp-do-in-six-months-before-presidential-election.html">in recent years</a>), and this weakens investors’ demand for dollars. Investors also fear that Donald Trump is not coping with the COVID-19 crisis, especially on the health front. </p>
<p>A cheaper currency has made imports more expensive for the US and has therefore further worsened the domestic economy. Yet it has also affected many other variables of the world economy. As other currencies have appreciated, exporting economies such as Brazil and India have suffered a lot. Consequently international investors have re-oriented their portfolios towards other developed economies, particularly European ones. </p>
<p>On the other hand, all countries with their currencies pegged to the dollar (especially those in the Middle East) have become more competitive. This has offset the damage from both the pandemic and declining oil prices. </p>
<h2>The longer view</h2>
<p>On the whole, we shouldn’t worry too much about the weaker dollar. It is still relatively strong, having appreciated 17% against the euro between 2010 and 2020 even allowing for its current weakness. On the whole, <a href="https://www.reuters.com/article/us-usa-markets-dollar-analysis/as-dollar-slides-some-investors-fret-about-its-status-as-worlds-reserve-currency-idUSKCN2511ID">the concerns</a> about the future of the dollar as the world’s reserve currency are probably unfounded. </p>
<p>The dollar will probably rise as the political uncertainties are resolved, and this will happen sooner rather than later. I think we have seen the worst already. The greenback has already risen slightly in the past couple of days, although there could always be further slight depreciation to come. </p>
<p>For the next year, the financial markets now expect only mild adjustment: the US$ to euro 12-month <a href="https://www.barchart.com/forex/quotes/%5EEURUSD/forward-rates">forward rate</a> – what the euro will be worth in US$ a year from now – is 1.19553 as of August 21, only 0.7% lower than the current trading rate. And 24 months from now, the dollar is expected to be 1.5% higher against the euro than at present. </p>
<p>Gold prices are another signal of comfort. When the dollar falls, gold rises. As of mid-August, gold prices had risen by around 30% since January 1. In five years, gold <a href="https://uk.tradingview.com/symbols/TVC-GOLD/">has appreciated</a> by almost 80%, equivalent to 12% on an annualised basis. </p>
<p>By comparison, in the same period the S&P 500 has returned 10% on an annualised basis, and only 5% since the beginning of the year. However, <a href="https://www.marketwatch.com/investing/future/gcq21">gold forward prices</a> – what the market thinks gold will be worth in future – are coming down now: they peaked in early August, and are now back to the levels of one month ago.</p>
<p>In conclusion, we should not expect a completely new financial order where, perhaps, a basket of global currencies or the Chinese yuan or Swiss franc take over from the US dollar as the world’s reserve currency. Most global trade transactions will still be denominated in the US currency; oil and other commodity prices will be in dollars; US stock markets will for a long time be the largest and prices of securities will be mostly dollar-denominated. The dollar may be soft, but not for long.</p><img src="https://counter.theconversation.com/content/144887/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Arturo Bris does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The greenback has taken a pounding in 2020, but it’s about to make a comeback.Arturo Bris, Professor of Finance, International Institute for Management Development (IMD)Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1024832019-02-05T19:10:47Z2019-02-05T19:10:47ZWhat caused hyperinflation in Venezuela: a rare blend of public ineptitude and private enterprise<p>Imagine going to the store and finding that nothing has a price tag on it. Instead you take it to the cashier and they calculate the price. What you pay could be twice as much, or more, than an hour earlier. That’s if there is even anything left in stock. </p>
<p>This is the economic reality that underpins Venezuela’s current “political crisis” – though in truth that crisis has been going on for years. </p>
<p>The government headed by Nicolás Maduro, who has presided over Venezuela since 2013, declared a state of emergency in 2016. That year the inflation rate hit 800%. Things have since gone from bad to worse. </p>
<p>By 2018 inflation was an estimated 80,000%. It’s difficult to say what the rate is now, but Bloomberg’s <a href="https://www.bloomberg.com/features/2016-venezuela-cafe-con-leche-index/?terminal=true">Venezuelan Cafe Con Leche Index</a>, based on the price of a cup of coffee, suggests it is now about 380,000%.</p>
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<p>About <a href="https://www.unhcr.org/news/press/2018/11/5be4192b4/number-refugees-migrants-venezuela-reaches-3-million.html">3 million Venezuelans</a> – a tenth of the population – have fled the country. This is the largest human displacement in Latin American history, driven by shortages of everything including food as well as the Maduro regime’s <a href="https://www.amnesty.org/en/countries/americas/venezuela/report-venezuela/">oppressive treatment of dissent</a>. </p>
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Read more:
<a href="https://theconversation.com/venezuela-is-fast-becoming-a-mafia-state-heres-what-you-need-to-know-109887">Venezuela is fast becoming a 'mafia state': here's what you need to know</a>
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<p>No wonder, then, that Maduro, who has just begun his second term as president, is now under considerable domestic and international pressure to call new elections.</p>
<p>So how did things get so bad? How did inflation become hyperinflation in Venezuela? And how do Venezuelans deal with it?</p>
<h2>The cost of goods and the value of currency</h2>
<p>What we pay for goods and services reflects not only their cost of production but also of the value of the currency we buy them in. If that currency loses value against the currency the goods are sold in, the price of those goods goes up. </p>
<p>By 2014 the value of Venezuela’s currency, the bolívar, and the prosperity of the Venezuelan economy, was highly dependent on oil exports. More than 90% of the country’s export earnings came from oil.</p>
<p>These export earnings had enabled the government headed by Hugo Chavez from 1999 to 2013 to pay for social programs intended to combat poverty and inequality. From subsidies for those on low incomes to health services, the government’s spending obligations were high.</p>
<p>Then the global price of oil dropped. Foreign demand for the bolívar to buy Venezuelan oil crashed. As the currency’s value fell, the cost of imported goods rose. The Venezuelan economy went into crisis. </p>
<p>The solution of Venezuela’s new president Nicolas Maduro, who succeeded Chavez in March 2013, was to print more money.</p>
<p>That might seem silly, but it can keep the economy moving while it gets over a hump caused by a short-term price shock. </p>
<p>The Venezuelan crisis, however, just got worse as the oil price continued to fall, compounded by other factors that reduced Venezuelan oil output. International investors began looking elsewhere, driving the value of the bolívar even lower.</p>
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Read more:
<a href="https://theconversation.com/curious-kids-why-dont-poorer-countries-just-print-more-money-107633">Curious Kids: why don’t poorer countries just print more money?</a>
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<p>In these conditions, printing more money simply made the problem worse. It added to the supply of currency, pushing the value down even further. As prices rose, the government printed more money to pay its bills. This cycle is what causes hyperinflation. </p>
<h2>Playing the currency market</h2>
<p>Circumstances like these quickly make saving money in the local currency nonsensical. To protect themselves, Venezuelans started to convert their savings into a more stable currency, like the US dollar. This lowered the value of the bolívar even further.</p>
<p>The government responded by issuing currency controls. It set a fixed exchange rate, to stop the official value of the bolívar dropping against the US dollar, and made it difficult to actually get permission to exchange bolívares into US dollars. The idea was to stabilise the currency by effectively shutting down all currency transactions.</p>
<p>US dollars were still available on the black market, however. This meant going to any number of operators on the streets of downtown Caracas or asking a friend to hook you up. As the crisis deepened, more and more Venezuelans looked to switch their bolívares into US dollars. </p>
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<a href="https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/257179/original/file-20190205-86233-6r2unm.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">By mid-2018 the official foreign exchange rate was about 250,000 bolívares to one US dollar.</span>
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<p>This increasing demand meant the black market price for greenbacks rose, creating a difference between the official exchange rate (set by the government) and the unofficial going rate. </p>
<p>With this came new opportunities. In 2014 reports emerged that groups of middle-aged women were crossing the border to use ATMs in Colombia. They could withdraw funds from their Venezuelan accounts as US dollars at the official rate. They could then cross back into Venezuela and exchange the dollars for bolívares at the unofficial rate, making a tidy profit. Government officials able to exchange bolívares for US dollars within Venezuela had their own version of this practice. </p>
<p>This pushed the price of US dollars up, and that of bolívars down, even more. As the crisis deepened increasing numbers of ordinary Venezuelans began to engage in the unofficial currency market. </p>
<p>Sometimes this took the form of taking subsidised Venezuelan goods like food across the border to sell. This earned the sellers foreign currency, but it also exacerbated shortages of goods within the country, driving prices up even further. </p>
<p>This does not mean Venezuela’s currency crisis is the fault of ordinary Venezuelans. Illegal economic activity is largely a coping mechanism, a bellwether of the actual economy’s ability to provide for people. When a government fails its responsibilities, it should be no surprise that people protect themselves through unofficial currency trading. This is exactly what big international investors do all the time, albeit through more official channels. </p>
<h2>Cannot be trusted</h2>
<p>By August 2018 the Venezuelan currency was worth so little that it was more prudent to <a href="https://www.bbc.com/news/world-latin-america-45246409">use cash for toilet paper</a> rather than buy toilet paper. </p>
<p>The government tried to get on top of this situation by issuing a currency devaluation. Maduro devalued the bolívar by 95%, the largest currency devaluation in contemporary world history. He also tied the new currency to the price of oil, an economic experiment designed to show the Venezuelan economy had solid foundations. </p>
<p>By bringing the bolívar’s value into line with the reality of what people actually thought it was worth, and showing it was backed by something valuable, oil, Maduro’s government hoped Venezuelans would believe in their own currency and not exchange it for dollars. This would help stabilise the economy overall.</p>
<p>But within weeks of the devaluation it was clear ordinary Venezuelans had not been convinced.</p>
<p>They had no reason to be, given the government was not addressing other issues, such as policies contributing to low productivity across the economy. The government’s increasing authoritarianism, including interfering with the constitution and elections, also signalled it was not to be trusted. </p>
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Read more:
<a href="https://theconversation.com/is-authoritarianism-bad-for-the-economy-ask-venezuela-or-hungary-or-turkey-106749">Is authoritarianism bad for the economy? Ask Venezuela – or Hungary or Turkey</a>
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<p>Hyperinflation is a very difficult hole out of which to climb. Very few economies ever experience it, and it’s hard to stop it without massively cutting government spending. </p>
<p>It is easy, then, to see why millions of Venezuelans responded by dealing in the black market or taking their savings, and themselves, out the country altogether. </p>
<p>As the political crisis in the country deepens, Venezuelans will have to continue to seek ways to allow them to survive the storm any way they can.</p><img src="https://counter.theconversation.com/content/102483/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michelle Carmody does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Venezuela’s hyperinflation has been caused by an inept public policy of printing more money and private individuals making the most of differences between official and unofficial exchange rates.Michelle Carmody, Academic Specialist, Latin America, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1087662019-01-02T10:05:52Z2019-01-02T10:05:52ZFive reasons Bitcoin could enter a more extreme death spiral<figure><img src="https://images.theconversation.com/files/251510/original/file-20181219-45413-1h9phnm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/gold-bitcoin-falling-apart-graph-crashing-1038671149?src=s5SU9NtxQR1Vyak0CveZBA-1-0">Shutterstock</a></span></figcaption></figure><p>Back in December 2017, when its price reached <a href="https://www.coindesk.com/900-20000-bitcoins-historic-2017-price-run-revisited">close to US$20,000</a>, Bitcoin looked like it had finally disrupted financial markets with the potential to <a href="https://www.coindesk.com/bitcoin-gone-mainstream-thats-big-deal">enter the mainstream</a>. A year later and things looked quite different. Bitcoin is now steadily trading below US$4,000 and has been constantly on a downward ride over the last year, losing more than half of its market capitalisation. </p>
<p>And yet cryptocurrency enthusiasts seem to ignore the fact that Bitcoin could yet enter an even more extreme death spiral. Bitcoin is not the only cryptocurrency whose market capitalisation has been hammered. Sell offs have happened across the board, with the price of major alternative coins such as Ripple and Ethereum falling in the past year.</p>
<p>It is not clear what the catalyst was for these price drops and selling. But what is clear is that cryptocurrency prices struggle to find a floor for a number of reasons. These range from the rising cost of mining, regulatory concerns, market manipulation, speculative trading, sky high power consumption, and the increasing scepticism from both the public and the world’s established financial industry.</p>
<h2>1. Rising cost of mining</h2>
<p>If its price continues to drop and the mining costs do not fall to the same extent, the incentives to update the public ledger and validate transactions can quickly disappear, threatening the very existence of Bitcoin as a viable payment system. </p>
<p>Bitcoin is dependent on a <a href="https://theconversation.com/why-energy-sapping-bitcoin-mining-is-here-to-stay-92138">system of miners</a> that verify transactions and record them on a digital ledger called the blockchain. This prevents copies being made of the digital tokens. As a reward for the energy and time involved, <a href="https://theconversation.com/how-do-you-mine-bitcoin-and-is-it-still-worth-it-55977">miners are rewarded in Bitcoin</a>.</p>
<p>But the amount of work involved in mining keeps increasing (making it more costly), as the mining process was always designed to get more and more difficult, to limit the number of new Bitcoin that get issued. Seeing as mining requires vast amounts of energy, a number of miners have <a href="https://www.coindesk.com/600k-bitcoin-miners-shut-down-in-last-2-weeks-f2pool-founder-estimates">shut down their operations</a>, as Bitcoin’s declining value has made mining less profitable.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/251512/original/file-20181219-45419-8pyhhr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/251512/original/file-20181219-45419-8pyhhr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/251512/original/file-20181219-45419-8pyhhr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/251512/original/file-20181219-45419-8pyhhr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/251512/original/file-20181219-45419-8pyhhr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/251512/original/file-20181219-45419-8pyhhr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/251512/original/file-20181219-45419-8pyhhr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Bitcoin mining takes a lot of energy.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/bitcoin-mining-farm-hardware-electronic-devices-772693789?src=_ufQc5P6UxPLtMEEhbKwWg-1-6">Shutterstock</a></span>
</figcaption>
</figure>
<p>This is worrying for Bitcoin’s viability as there needs to be a minimum number of miners at work to maintain the public blockchain ledger. Without the mining activity, cryptocurrencies are just a set of encrypted numbers with no value. Any rational investor would stand clear of mining if the cost of mining is higher than the future price. </p>
<h2>2. Regulatory concerns</h2>
<p>Regulators across the world are beginning to act on cryptocurrencies with diverging views. While countries like <a href="https://news.bitcoin.com/switzerland-to-relax-laws-to-accommodate-blockchain-and-cryptocurrency-startups/">Switzerland</a> and <a href="https://cointelegraph.com/news/from-malta-to-prague-what-is-the-most-crypto-friendly-travel-destination">Malta</a> are trying to become hubs for cryptocurrency businesses, others like <a href="https://www.cnbc.com/2018/09/03/china-clamps-down-on-cryptocurrency-speculation.html">China</a> and the <a href="https://www.fxstreet.com/cryptocurrencies/news/cryptocurrency-market-update-the-us-sec-sweeps-crypto-space-clean-ethereum-takes-the-biggest-hit-201809121105">US</a> have cracked down on cryptocurrency markets. </p>
<p>A case in point comes from the US markets regulator, the SEC. It <a href="https://www.sec.gov/news/press-release/2018-264">announced in November 2018</a> that operators of two <a href="https://theconversation.com/explainer-what-are-initial-coin-offerings-icos-and-why-are-investors-flocking-to-them-84330">initial coin offerings</a> (ICOs) must pay fines and restitution as they broke the law by selling unlicensed securities. This hardly comes as a surprise. In fact, it is likely only the beginning of a decisive intrusion of regulatory bodies in the opaque ecosystem of ICOs. Such a development might be enough to spook some investors to abandon cryptocurrencies altogether.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/bitcoins-rollercoaster-ride-reflects-the-biggest-issue-facing-cryptocurrencies-regulation-101690">Bitcoin's rollercoaster ride reflects the biggest issue facing cryptocurrencies: regulation</a>
</strong>
</em>
</p>
<hr>
<p>Advocates of cryptocurrencies insist that more institutional investors will get involved in the space thanks to new products such as crypto-specific exchange-traded funds (ETFs). They expect these to take off in the same way that ETFs have become massively popular <a href="https://citywire.co.uk/wealth-manager/news/rise-of-etfs-active-managers-must-evolve-or-die/a1091464">for conventional investors</a>. But the SEC has not approved any crypto ETFs, and it would be overly optimistic to assume that this will happen in the near future. </p>
<h2>3. Market manipulation</h2>
<p>Market manipulation and speculative activity are also important concerns when it comes to the crypto market, which could have been priced into recent performance. My <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3077685">recent research shows</a> how well-informed traders buy cryptocurrencies in bulk, which pushes the price up and gets other buyers to follow suit, until the well-informed traders sell and send the price down, which again everybody follows.</p>
<p>Again, this hardly comes as a surprise. Cryptocurrency markets are incredibly opaque. Anyone paying attention to cryptocurrency trading knows that this kind of pump-and-dump activity and fictitious orders are designed to artificially move prices, exacerbating price swings at the expenses of, perhaps unsophisticated, retail investors. </p>
<h2>4. Power consumption</h2>
<p>A third concern behind the constant price drop is the increasing costs of equipment and electricity. Bitcoin mining is incredibly power hungry. And this power demand is becoming so high in regions where mining is concentrated, such as Canada, that authorities are starting to <a href="https://www.bloomberg.com/news/articles/2018-06-07/quebec-halts-bitcoin-mining-power-requests-amid-booming-demand">deny supply to mining facilities</a>. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/bitcoins-high-energy-consumption-is-a-concern-but-it-may-be-a-price-worth-paying-106282">Bitcoin's high energy consumption is a concern – but it may be a price worth paying</a>
</strong>
</em>
</p>
<hr>
<p>Again, this could threat the very survival of any cryptocurrency which is based on mining. This represents the vast majority. </p>
<h2>5. Industry scepticism</h2>
<p>Large drops in prices are accompanied by a persistent scepticism around cryptocurrencies. To some extent this is due to the fact that the promise to bypass the mainstream, centralised economic system and enable peer-to-peer payments has been disappointing so far. </p>
<p>Major players in the world of finance, such as Berkshire Hathaway’s <a href="https://www.cnbc.com/2018/05/01/warren-buffett-bitcoin-isnt-an-investment.html">Warren Buffett</a> and JP Morgan Chief Executive <a href="https://www.marketwatch.com/story/jamie-dimon-i-dont-really-give-a-shit-about-bitcoin-2018-10-31">Jamie Dimon</a>, constantly express their deep scepticism of cryptocurrencies, suggesting Bitcoin and the likes still face an uphill battle for acceptance. </p>
<p>The one upside to all this is that, although cryptocurrencies may have entered a death spiral, the blockchain economy is here to stay. As well as allowing safe peer-to-peer lending and transactions, it is being used to build more efficient supply chains and in the evolution of the internet of things – to name just a few of its applications. This will only grow as it is applied to everything from <a href="https://www.frontiersin.org/journals/blockchain">education</a> to the <a href="https://civil.co/">media</a>.</p><img src="https://counter.theconversation.com/content/108766/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Daniele Bianchi consults to Aaro Capital Ltd in London. </span></em></p>Bitcoin has been on a downward ride over the last year, steadily trading below US$4,000. It could get worse.Daniele Bianchi, Assistant Professor of Finance, Warwick Business School, University of WarwickLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/922952018-02-25T20:18:47Z2018-02-25T20:18:47ZLIBOR: elections, manipulations – and a possible fix<figure><img src="https://images.theconversation.com/files/207522/original/file-20180222-152363-13zyo3f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">London's financial district at night.</span> <span class="attribution"><a class="source" href="https://unsplash.com/photos/NaWJWzmprZQ">Gordon Williams/Unsplash</a></span></figcaption></figure><p>While some first political and economic consequences of the <a href="https://theconversation.com/uk/eu-referendum-2016">Brexit vote</a> are already visible, London’s role in the world financial markets has been so far relatively unaffected. The high density of financial institutions combined with a longstanding tradition of the banking industry makes the role of the City in the financial arena rather stable.</p>
<p>Among the several indexes located in this financial powerhouse is the <a href="https://www.theice.com/iba/libor">ICE London Interbank Offered Rates</a> – commonly known by its acronym, LIBOR. Since the <a href="https://www.theguardian.com/business/2017/jan/18/libor-scandal-the-bankers-who-fixed-the-worlds-most-important-number">2008 rigging scandal</a> there has been some discussion of <a href="https://www.theguardian.com/business/2017/jul/27/libor-interest-rate-phased-out-scandals">phasing it out</a>, but it remains a key index in the world’s financial markets.</p>
<p>Each LIBOR rate determines the interest rate at which banks lend each other money for some length of time (ranging from 1 day to 12 months) on different currencies (dollars, euros, etc.). These benchmark rates are widely used as a base interest rates by financial institutions all over the world since many contracts are paid at least the interest corresponding to some LIBOR rate.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/207510/original/file-20180222-152348-1jut9n7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/207510/original/file-20180222-152348-1jut9n7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=405&fit=crop&dpr=1 600w, https://images.theconversation.com/files/207510/original/file-20180222-152348-1jut9n7.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=405&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/207510/original/file-20180222-152348-1jut9n7.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=405&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/207510/original/file-20180222-152348-1jut9n7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=509&fit=crop&dpr=1 754w, https://images.theconversation.com/files/207510/original/file-20180222-152348-1jut9n7.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=509&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/207510/original/file-20180222-152348-1jut9n7.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=509&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Figure 1: Two LIBOR rates since 2008: EUR at 12 months and USD 3 months.</span>
<span class="attribution"><span class="source">St. Louis Fed.</span>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>Therefore, the LIBOR rates impact directly and indirectly small businesses as well as corporations, the world’s largest banks and almost any financial product such as loans, mortgages and derivatives. Arguably, the LIBOR rates are among the world’s most important numbers. It is often thought as a good barometer of the global economic and financial situation. </p>
<p>Figure 1 depicts the evolution of two of these rates since 2008: the one corresponding to loans in euros for 12 months and the one corresponding to loans in US dollars for three months. One can distinguish clearly three different regions. In first one, spanning from the beginning of 2008 until mid 2010, where both indexes are in decline, corresponds to the aftermath of the subprime financial crisis. The second period, that ends at the beginning of the year 2015, corresponds to some stable period in which both rates do not move much the EUR12 being higher than the USD3 one. The final region, that lasts until today, corresponds to an unusual period in which the EUR12 is negative while the USD3 is positive and increasing. What can one infer from these indexes ? How is each index determined?</p>
<h2>Elections and manipulations</h2>
<p>A distinct feature of these rates is that its value is not determined through a market but through an election. More precisely, a daily election is held in which a selected sample of 18 banks takes part. Each bank reports a value (interest rate) which represents the rate at which it is ready to lend money in this currency for certain amount of time. The extreme reports (the top and the bottom four) are removed and the LIBOR corresponds to the average of the remaining values. Figure 2 explains this computation with five banks and the deletion of the top and the bottom value.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/207511/original/file-20180222-152360-vq4lw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/207511/original/file-20180222-152360-vq4lw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=154&fit=crop&dpr=1 600w, https://images.theconversation.com/files/207511/original/file-20180222-152360-vq4lw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=154&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/207511/original/file-20180222-152360-vq4lw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=154&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/207511/original/file-20180222-152360-vq4lw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=194&fit=crop&dpr=1 754w, https://images.theconversation.com/files/207511/original/file-20180222-152360-vq4lw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=194&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/207511/original/file-20180222-152360-vq4lw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=194&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Figure 2: Example of LIBOR computation with five banks.</span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>The logic of the LIBOR computation is made transparent in Figure 2: the first step, dropping the extreme reports, invalidates the extreme reports whereas the second one simply averages the moderate ones, leading to a LIBOR of 0.527%. The role of the second step is to represent in a consensual manner the moderate values. In a sense, one could argue that this method tries to give incentives for consensus since none of the banks has an interest in announcing a value too different from the rest of the announcements. Yet, since the financial crisis in 2008, manipulation in the LIBOR (often referred to as the LIBOR scandal) casts some doubts over the way this index is determined.</p>
<p>In the 2008 LIBOR scandal, some banks altered their reports so as to obtain a value that fitted better their own interests. For instance, a report by the United Kingdom Financial Services Authority (FSA) <a href="https://www.fca.org.uk/news/press-releases/barclays-fined-%C2%A3595-million-significant-failings-relation-libor-and-euribor">stated that</a>:</p>
<blockquote>
<p>“Barclays’ misconduct was serious, widespread and extended over a number of years. The integrity of benchmark reference rates such as LIBOR and EURIBOR is of fundamental importance to both UK and international financial markets. Firms making submissions must not use those submissions as tools to promote their own interests”.</p>
</blockquote>
<p>If every bank announces honestly its preferred interest rate, this method is arguably close to perfect. However, a reasonable question is whether banks have the incentives to do so under this method. If not, this casts some shadow over this manner of computing LIBOR.</p>
<p>To understand the logic of a manipulation in a simple manner, consider that in Figure 2 every bank is honestly announcing its preferred interest rate. For instance, this implies that Société Generale’s preferred rate is 0.52%. What is the consequence of a misreport with this system? As long as the report is not too extreme, that is located in between the ones of Rabobank and Crédit Suisse, a misreport (or strategic report) affects the outcome. If for instance, S.G. announces 0.499, then the final outcome is 0.52: namely, by misreporting, S.G. obtains its preferred rate (see Figure 3 for an explanation). This leads to the following conclusion: the classical method for computing LIBOR gives banks incentives not to report their preferred interest rate but rather to strategise as a function of the expected reports of the rest of the banks.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/207512/original/file-20180222-152357-mftw5a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/207512/original/file-20180222-152357-mftw5a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=146&fit=crop&dpr=1 600w, https://images.theconversation.com/files/207512/original/file-20180222-152357-mftw5a.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=146&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/207512/original/file-20180222-152357-mftw5a.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=146&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/207512/original/file-20180222-152357-mftw5a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=183&fit=crop&dpr=1 754w, https://images.theconversation.com/files/207512/original/file-20180222-152357-mftw5a.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=183&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/207512/original/file-20180222-152357-mftw5a.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=183&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Figure 3: A misreport might be beneficial for a bank.</span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<h2>A proposal</h2>
<p>Can we find reasonable ways of building the LIBOR rate without this undesirable feature? One can always design sophisticated methods to check whether the reported values are indeed sincere, yet this comes at the cost of thin auditing methods which can be rather inefficient. Yet, this method will still lie in the setting in which banks are always tempted to manipulate the true valuation, which might in turn create new problems with fake reports. Our view is that the purpose of the LIBOR method is to design a method which is simple and practical while at the same time it represents well the different preferences of the banks. Namely, if one wants to improve the computation of the LIBOR, one needs to design an instrument that moderates the final decision while it leads to a consensual final rate.</p>
<p>This <a href="https://www.sciencedirect.com/science/article/pii/S0022053117300558">has led us to design methods</a> that escape from the dilemma of reporting the true value versus manipulating via reporting a strategic value. One of these methods works as follows: each bank reports a range of values and not anymore, as in the original LIBOR, a single value. Namely, rather than reporting 0.52 and 0.499 as in Figures 2 and Figure 3, the Société Générale is now allowed to announce any range of interest rates: for example, in Figure 4, S.G. announces any value from 0.231 until 0.841. This means that S.G. approves of any value in this interval.</p>
<p>The interval method computes the LIBOR in a different manner. Rather than dropping values, it considers the different intervals announced by the different banks as a sample of points (see Figure 4b). Given this sample of points, it plots the distribution of the approvals made by the different banks (Figure 4c). Finally, it selects the value that divides in two exact halves the sample of points generated by the banks’ announcements.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/207830/original/file-20180226-140197-1hy5rtb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/207830/original/file-20180226-140197-1hy5rtb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=395&fit=crop&dpr=1 600w, https://images.theconversation.com/files/207830/original/file-20180226-140197-1hy5rtb.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=395&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/207830/original/file-20180226-140197-1hy5rtb.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=395&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/207830/original/file-20180226-140197-1hy5rtb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=497&fit=crop&dpr=1 754w, https://images.theconversation.com/files/207830/original/file-20180226-140197-1hy5rtb.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=497&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/207830/original/file-20180226-140197-1hy5rtb.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=497&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Figure 4: Computing the LIBOR with intervals.</span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>How should we expect banks to behave under this method? Theoretically, this method should lead to selecting (a very accurate estimation of) the median preferred interest rate of the banks. The idea behind the median interest rate is quite familiar in economics and political science: the Condorcet winner. Consider the ideal point of each bank and order them from the lowest to the highest one. The median interest rate is the one that divides the sample of ideal points in two exact halves since half of these values are lower than the median interest rate and half are higher. An important property of the median interest rate is its democratic appeal: it turns out that if one starts comparing by pairs each of the ideal points of the different banks, the only interest rate that defeats by a majority any other ideal point is the median interest rate. It is hence a basic desideratum for respecting the will of the banks to ensure that the outcome is as close as possible to the median of the ideal points.</p>
<p>This convergence to the median should occur since a bank’s ideal strategy is to announce either all the interest rates to the left of the outcome or all the alternatives to the right of it. The bank should theoretically announce all alternatives located to the left of the outcome if its interest rate is lower than the outcome whereas it announces all alternatives to the right of the outcome if its ideal interest rate is higher. In practice, few are known. </p>
<p>Some experiments have been run in the Cyprus Experimental Economics Lab at the University of Cyprus, and while it is still early, the first available results are encouraging. In a lab setting, we endow players with a minute to decide over the interval they want to announce. During this period of time, they are allowed to play with the intervals while seeing in real-time the announcements of the rest of the players. Most experimental subjects tend to understand well the mechanism and the outcome is quite close to the median of the players’ ideal points. More importantly, players seem to be much more satisfied with the final outcome than with the usual methods so that the method increases the consensual views of the different players.</p>
<h2>Final remarks</h2>
<p>The LIBOR rates are core tools in the global financial system. It is then essential to ensure that these rates are well-calibrated so that they reflect well the will of the different banks involved in its construction. While the LIBOR scandal underlined some weaknesses in the initial method of computation, a myriad of possible fixes might be available. Our proposal is to offer each of the banks more flexibility, allow each to announce ranges of interest rates. While more evidence is needed on the benefits of this system, the current <a href="https://www.sciencedirect.com/science/article/pii/S0022053117300558">theoretical and experimental results</a> make this approach a potentially interesting one. A key advantage is that banks would no longer face the usual dilemma between being sincere or opting for their self-interest, removing any potential auditing costs.</p><img src="https://counter.theconversation.com/content/92295/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Les auteurs ne travaillent pas, ne conseillent pas, ne possèdent pas de parts, ne reçoivent pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'ont déclaré aucune autre affiliation que leur organisme de recherche.</span></em></p>The London Interbank Offered Rates is one of the world’s key financial tools, but the 2008 rigging scandal has led to calls for its being phased out. Can we find better ways of building the LIBOR rate?Matias Nunez, CNRS Researcher in Economics, Université Paris Dauphine – PSLDimitrios Xefteris, Assistant Professor of Political Economy, University of CyprusLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/829442017-08-31T07:34:01Z2017-08-31T07:34:01ZWhy London still shouldn’t worry about losing business to Frankfurt, Paris, or any other EU city<figure><img src="https://images.theconversation.com/files/183295/original/file-20170824-18728-1kvg7l9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><p>Japanese banks Nomura and Daiwa recently indicated they are moving their EU base <a href="https://www.bloomberg.com/news/articles/2017-06-22/nomura-said-to-choose-frankfurt-as-european-base-after-brexit">to Frankfurt</a> and are applying for the appropriate regulatory licences. The announcements follow similar ones from <a href="https://www.theguardian.com/business/2017/jul/19/morgan-stanley-picks-frankfurt-post-brexit-hub">Morgan Stanley</a> and <a href="https://www.bloomberg.com/news/articles/2017-06-18/goldman-to-double-frankfurt-staff-on-brexit-europe-head-says">Goldman Sachs</a>, among others. Mitsubishi, however, <a href="https://www.ft.com/content/158dcffe-7535-11e7-90c0-90a9d1bc9691">seems to prefer Amsterdam</a> and – oh, the irony – so does the largely <a href="https://uk.reuters.com/article/us-britain-eu-rbs-idUKKBN1AK0L8">UK-government-owned RBS</a>. </p>
<p>With every announcement of this nature, up goes the cry that the UK’s finance industry will be crippled by Brexit as bankers flee, and European cities including Dublin and Paris, in addition to Amsterdam and Frankfurt, look to hoover up business. So, is London about to become emptied of its financial industry and will tumbleweed blow around the square mile? And why, then, are some banks (<a href="http://uk.businessinsider.com/wells-fargo-buys-new-london-office-despite-brexit-2016-7">such as Wells Fargo</a>) moving in.</p>
<p>In weighing up the argument between the camps that think the UK’s finance industry will be decimated against those who don’t, we need to sift through what is known, what is assumed and what can change. This includes how hard a Brexit it will be and whether or not the current government will survive, along with endless other questions. </p>
<h2>What we know</h2>
<p>What hasn’t changed is the location of the UK and its history as a financial centre. Yes, given its mid-way point between US and Asian markets and time zones, this is important. Thanks to its location and <a href="http://www.economist.com/node/8058157">years of favourable policies</a>, London has more international banks than any other city in the world. This scale gives London an edge over other European cities, and the fragmentation of financial centres to Dublin, Frankfurt and others, is undesirable. </p>
<p>It also hasn’t changed that the UK trades more dollars than anywhere else, <a href="https://www.poundsterlinglive.com/gbp-live-today/5435-london-foreign-exchange-turnover-data-2016">including the US</a>, and it also trades more Chinese yuan than anywhere else <a href="https://www.ft.com/content/9fd82346-0cf2-11e6-b41f-0beb7e589515">except Hong Kong</a>. For now, the US dollar is the world’s most traded, and most important, currency. Many will argue that this position will ultimately be replaced by the yuan. </p>
<p>Moreover, London doesn’t trade just a little bit more than other financial centres, it trades almost double the amount of currency that is traded in New York and accounts for almost 40% of global trade. Any movement in the dominant position of London is <a href="https://theconversation.com/why-london-wont-lose-its-crown-as-europes-financial-capital-63362">likely to come from further east</a>, with Hong Kong and Singapore leading that charge. Trading in the US dollar and euro are down while trading in the Chinese yuan and other Asian currencies is <a href="http://www.bis.org/publ/rpfx16fx.pdf">increasing rapidly</a>, reflecting their increasing importance in global trade. </p>
<p><iframe id="b32zf" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/b32zf/3/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>Losing membership of the EU may dent these figures, but what lies behind them is a significant amount of expertise and infrastructure that cannot simply be picked up and relocated in multiple cities. This means human capital that banks do not want to spread in different locations, assuming said human capital wishes to move. </p>
<p>But it also includes the extensive infrastructure built by banks since the “big bang”, as the huge regulatory changes that took effect in 1986 are known and that saw the beginning of international banks move to London. This infrastructure includes the human elements, as banks need lawyers, insurance specialists, risk managers and the like. But it also includes the physical infrastructure. Increasingly important in this, is the cabling and IT equipment required for high frequency trading. Both Atlantic undersea internet cabling and local industry data centres well serve the UK and London. </p>
<h2>Into the unknown</h2>
<p>Nothing has actually changed yet (Brexit will not be official until April 2019). Moreover, the banks noted above (and others) are largely looking for office space. No one has jumped ship yet. These are contingencies you would expect any business to make when it is faced with the uncertainties surrounding soft vs hard Brexit – office space can get snapped up quickly. </p>
<p>London <a href="https://www.ft.com/content/18dcf566-5025-11e7-bfb8-997009366969">trades trillions in euros</a> and has a large euro-denominated insurance industry. This is the currency most at risk, if the UK fails to secure post-Brexit passporting rights.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/183296/original/file-20170824-18706-89puh0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/183296/original/file-20170824-18706-89puh0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/183296/original/file-20170824-18706-89puh0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/183296/original/file-20170824-18706-89puh0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/183296/original/file-20170824-18706-89puh0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/183296/original/file-20170824-18706-89puh0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/183296/original/file-20170824-18706-89puh0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">London is set up as the centre of global currency trading.</span>
<span class="attribution"><span class="source">shutterstock.com</span></span>
</figcaption>
</figure>
<p>But a valid question is: can Europe handle this amount of trading? The answer is, currently, no. The infrastructure isn’t there. It appears as though the powers that be within the eurozone realise this. The pan-European Euronext exchange <a href="https://www.ft.com/content/dfa2bd4e-7c3e-11e7-9108-edda0bcbc928">recently announced</a> that it would extend its contract with the London Stock Exchange-owned LCH clearing house for a further ten years. The existing contract is due to expire in 2018. As part of the deal, some clearing may go through the Paris branch, perhaps enough to satisfy the ECB, but most will likely still be handled by its London headquarters. </p>
<p>Ultimately, the UK will lose some euro business. This is inevitable because the European Commission <a href="https://www.ft.com/content/60cb441a-4f83-11e7-bfb8-997009366969">wants</a> more euro denominated clearing to be under the auspices of the ECB. But the process will be slow. Even those banks looking at office space across the euro area are talking of staff moves in the low hundreds or less, not the many thousands. </p>
<p>Brexit will bring many challenges to the UK and its economy, from concerns about whether there will be enough labour to pick crops and staff hospitals to the costs that firms may face if trading outside the customs union. The list of uncertainties is long. But in terms of London’s financial centre, the bigger threat is likely to come from much further east.</p><img src="https://counter.theconversation.com/content/82944/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David McMillan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Talk of banks leaving London completely for other European cities is just that – talk.David McMillan, Professor in Finance, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/689562016-11-23T10:08:53Z2016-11-23T10:08:53ZThe weaker pound is a mixed bag for UK PLC as rivals move to adapt<figure><img src="https://images.theconversation.com/files/146728/original/image-20161121-4544-lumu2r.jpg?ixlib=rb-1.1.0&rect=59%2C79%2C940%2C573&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-323763059/stock-photo-one-pound-coin-on-fluctuating-graph-rate-of-the-pound-sterling-shallow-dof.html?src=Dckjtmb8uQZwgIgJw27Gzw-2-84">Valeri Potapova/Shutterstock</a></span></figcaption></figure><p>The value of the pound plummeted after the Brexit referendum. From close to US$1.50 before the vote to leave the European Union, sterling has now found a new <a href="http://www.xe.com/currencycharts/?from=GBP&to=USD&view=1Y">level close to US$1.20</a>. This has been greeted as a welcome boost to UK exporters as it makes it cheaper for other countries to buy British goods. But this is a simplistic take. The reality is far more complicated and dependent on the markets in which these companies operate. </p>
<p>The <a href="http://www.thisismoney.co.uk/money/markets/article-3701788/What-sterling-s-slump-means-UK-s-economy-businesses-households.html">conventional wisdom</a> about a falling currency and exports fails to acknowledge some fundamental points. <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2843755">Our research</a> highlights that such analysis typically does not account for the existence and nature of a company’s competition, domestically and overseas. </p>
<p>In other words, nimble corporate rivals can quickly adapt to counter any potential gains from currency effects, and that applies to UK-focused firms as well as exporters. Let’s take an example from one of Britain’s favourite pastimes: beer. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/146782/original/image-20161121-4564-1qxeamg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The tippling point?</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/andywilkes/2481933944/in/photolist-4Mjyuy-6EsBky-2VK1Gm-GaA8f-9dSq2a-CXuzn-DDA12-iEwMm-39hwn6-5LMGRC-iEwKW-5RdGNR-3bmBpQ-4MjyBu-6DwLz5-6C68Ec-6Cagi5-8CaK7-2rbhJ-4MfoYz-6DwLif-BF7jy-9cYLym-397iC-98aXMm-6ffCew-6DsBHr-25pc5-24F2K-4TLWV-twRQ-9hvmws-H1eo-6DsBPB-2kd9y-ikoK-wTsuK-kSgo-rRHh-mvTQ-4oz3N-VU1U-4xRqce-twMg-o1Be-QuMp-mvVz-mvSF-hE3b-vSpd">Andy Wilkes/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<h2>Losing its fizz</h2>
<p>Our research studied data from 22 multinational firms and nine markets. One such firm was the brewer SABMiller, a British exporter, which competes in an <a href="http://www.economist.com/node/18651308">international duopoly</a> with Belgian group AB-InBev, the maker of beer brands such as Budweiser, Corona and Stella Artois. We looked at a period before the companies agreed a merger which was <a href="http://www.wsj.com/articles/sabmiller-ab-inbev-shareholders-approve-100-billion-plus-merger-1475059015">approved by shareholders in September</a>. </p>
<p>Now, under conditions of a falling pound, SABMiller would in theory enjoy an increase in its profits as foreign buyers snapped up products now markedly cheaper in their home currency. However, that assumes that its Belgian rival failed to cut its own product prices by what was required to offset the change in the GBP/EUR exchange rate. If AB-InBev is on the ball, and sensitive to exchange rate changes it can very easily decide to cut its product price by more than the increase in the exchange rate. In that scenario, the profits of SABMiller could fall.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/146783/original/image-20161121-4544-1u86zzd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Muscling in?</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/waltermera182/9514909861/in/photolist-bAE4RS-5k6Nad-9riTv7-5bdRpv-e6vzgM-84dYoJ-7ACBYj-8aT42e-88Gjd3-55QM1h-dHvgA-8fNbuC-dihQkj-4s7jic-dHvyK-8vt2aY-cvd7kS-dHvBH-59aMyo-6mdG3n-7mp44V-4bmT2C-25cRBJ-25cRRo-4bUN7Z-fv3EB7-4CPbKB-aS9xQt-fuNpd2-7UM9wi-ewBZ1s-38hDMs-8c8Pu6-s49Nv-EYo9vC">Walter Gustavo MERA MELO/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Then, what if you have to factor in a third competitor, such as the Netherlands-based Heineken, which shares the same currency as AB-InBev? This means that the exposure of SABMiller will also be affected by Heineken’s change in its product price in response to the exchange rate fluctuation of the euro relative to the pound. The picture here becomes more complex because the degree to which foreign competitors will change their product prices will also depend on the degree of competition between them in their own home markets. It will also depend on their desire to curb product prices in any attempt to offset a boost to the competitiveness of the UK firm; how much margin they are willing to sacrifice in order to stay competitive. </p>
<p>If our UK brewer also faces a domestic competitor then the picture becomes even more complex. SABMiller’s profits would also be affected by the pricing decisions of that local rival in response to changes in the exchange rate.</p>
<p>In short, these are far muddier waters than some would have you believe. The profits of UK-based exporters might enjoy a brief window of opportunity if rivals are slow to adapt, but earnings could just as easily take a hit from a rapidly changing environment as a sector gets used to new realities. Our conclusions don’t only apply to British exporters. It is the same for any multinational firms which face competitors at the international and local level. The sports market is another good example, with its <a href="http://www.economist.com/blogs/graphicdetail/2013/08/daily-chart-14">international oligopoly</a> of US firm Nike, the global leader, and two German firms, Adidas and Puma.</p>
<h2>Kindness</h2>
<p>It is clear the argument that a weakened currency makes domestic exporters better off is not necessarily true. Whether or not a fall in the currency is a good thing for an industry depends on the market structure, and specifically on the size of the price sensitivities with respect to exchange rates of their international competitors.</p>
<p>When <a href="https://www.theguardian.com/business/2016/jan/26/mark-carney-fails-to-rule-out-eight-year-term-at-bank-of-england">Mark Carney</a>, the governor of the Bank of England, said, that Britain “depends on the kindness of strangers”, he had in mind UK’s heavy current account deficit. We argue that British exporters also “depend on the kindness of rivals”. </p>
<p>There is a clear link between the ability of a firm to pass on the exchange rate changes to its customers and the magnitude of their exposure to rival firms operating in the same market, both domestically and overseas. In our example of the beer market, the ability of AB-InBev to pass on the increase in the euro to the price of its beer affects the profits of SABMiller. The higher the former is, the lower the profits of SABMiller will be. This clearly depends on how loyal (i.e. non-price sensitive) the consumers of the Belgian brewer and SABMiller are. </p>
<p>Our theoretical and empirical results suggest that a falling currency is not always good for exporters. If the companies ignore these complex relationships between firms’ price setting behaviour, profits and exchange rates, mistakes are more likely and sometimes these will benefit the exporters of the appreciating country at the expense of the firms in the depreciating country. </p>
<p>The idiosyncrasies of each market, and the price sensitivity of consumers, will play a significant role in determining whether a devaluation will be beneficial for the exporters of a country. Simplistic arguments that a weakened pound is good for British exporters fail to take these into account.</p><img src="https://counter.theconversation.com/content/68956/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>All the talk about a golden time for UK exporters forgets one crucial point.Xeni Dassiou, Reader in Economics, City, University of LondonAthanasios Andrikopoulos, Lecturer in Finance, University of HullLicensed as Creative Commons – attribution, no derivatives.