Foreign Exchange

FX FIX FIX: What does this mean for the ‘Free Market’?

The UK’s FCA is investigating whether banks are guilty of manipulating FX fixings.1 In the Libor fixing scandal, it was found that banks were systematically lying about their true cost of funding in order to make profits on their interest rate trading positions. In FX fixings however, it’s claimed (and it’s pretty much 100% sure to be true) that banks were systematically trading large amounts of FX right before the 4pm daily WMR fixing in order to push it around, a practice known in equity markets as ‘banging the close’. Note that there’s a crucial difference here. In Libor fixing, you lie through your teeth but don’t actually commit any money defrauding your counterparties. In FX fix fixing, you’ve actually got to go do some FX. You can say whatever you like but WMR fixings are based on the average price of the trades that go through electronic marketplaces at 4pm. If you want it to change, you’ve got to go spend some green.

But this is still universally considered bad. We don’t like manipulation of fixings or closing prices. Why not? After all, these are real trades done in a ‘free’ market, but it’s still bad. It enables those with a lot of market power to profit from manipulating prices. But this is all a touch circular, isn’t it? How do we know if prices are manipulated, given that there’s no such thing as an absolute fair value for Euros in terms of pounds? If a large bank comes in and smashes the fixing by buying €100 billion in terms of USD, the exchange rate will go up, but is it being manipulated? Sellers are raising their prices because they can see there is massive demand, so why do we consider this unfair?

The answer is that regulators, and free market types, actually have very strong normative beliefs about what markets should do. Markets are not there to enrich big banks, they are there to enable the free exchange of commodities or currencies or whatever, at prices that are mutually agreeable. Antisocial behaviour like buying a lot of Euros to manipulate a fixing is not good because it is against this norm – it’s not about price discovery or enabling free exchange. As a socialist, it’s encouraging to see that regulators are happy to take such a strong normative view, and tell large, powerful institutions that they are not allowed to express that power in the marketplace in this way. The Macro Man piece on this,2 while intended to be satirical, for me would represent steps in the right direction!

But there is a very important insight here. Markets don’t just exist. They aren’t free when regulators don’t interfere. The market isn’t freer by allowing a big bank to manipulate fixings, because then distortions mean that other participants cannot participate ‘freely’. The market in currencies exists for a reason, and regulators decide what that reason is and then alter the rules in order to have the market facilitate those goals. You’ll hear people talking a lot about the ‘Free Market’, but the only markets that exist are ones that we have built within the frames of our institutions and laws. People in financial markets like to think of themselves as savage animals, red in tooth and claw. But they are paper tigers in small cages. They are put to work, by the system, for a purpose. Bankers’ purported love of the ‘Free Market’ can be thought of in part as an egotistical defence against the truth: we are not intrepid, autonomous, cut-throat financial buccaneers, we are workers in a system just like everyone else. The reason free markets appear to protect privilege and enrich the wealthy is because they do this by design, and we need to own up to that. The day we open up to that is the day we can really start the conversation about how to make things better.




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