The British pound’s recent gyrations point to some basic lessons of currency markets. While an extremely overvalued US dollar and many other factors are at play, the main source of downward pressure on the exchange rate is the new UK government's bizarre lurch into Reaganomics.
LONDON – After earning my PhD in 1982, I spent the first 20 years of my professional career immersed in the tumultuous world of foreign-exchange markets. Today, current events are bringing back both happy and embarrassing memories.
I learned three things about currencies during that time. First, everyone may get their 15 minutes of fame (the Andy Warhol principle), but they shouldn’t expect it to last any longer than that. The forex market – the world’s biggest fruit and vegetable stall – tends to make idiots of those who think they’ve found the magic forecasting formula. That points to the second lesson: If I was “right” 60% of the time, I knew I should be content. Finally, floating exchange rates will always go up and down, except for when they are going down and up.
With these lessons in mind, the British pound’s current gyrations point to some other essential traits of currency markets. First, the pound’s sudden weakness comes at a time when the US dollar has grown extremely strong against all currencies, owing to markets’ belief that the US Federal Reserve will do whatever it takes to reduce inflation. Some currencies, such as the Japanese yen, have fallen even more than the pound so far this year. When inflation starts to ease and markets perceive that the Fed is done tightening, some of these developments will probably reverse.
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