Every once in a while, many smaller economic and market events combine to set off a currency meltdown. These meltdowns can be financially devastating to some - but at the same time, someone else is making money. While there have been many currency meltdowns of differing magnitudes, the ruble, euro, pound and kiwi have had their day in the speculative sun. The events that led to these meltdowns and the effects on the world and currency trading that these meltdowns had are important issues that should be remembered. Each currency meltdown offers insight into how traders could have avoided big losses or made big money. (Flying high one day, but not the next - see the stories behind some spectacular financial meltdowns. Check out Massive Hedge Fund Failures.)
TUTORIAL: Popular Forex Currencies
The 1998 Russian Financial Crisis hit on August 17, but it had been brewing since the Asian financial crisis took hold in July. There were many factors that played a role in the demise of the Ruble - not to mention the pounding it gave the stock and bond markets – and an artificial exchange rate that required the Ruble to stay within a pre-set band with the USD was one of them. There was also the Asian crisis and falling demand and prices for crude oil weighing on the Russian economy. In the middle of this mess, skyrocketing interest rates to prompt external inflows showed weakness instead of inspiring confidence, and debts to workers (many of them miners) continued to grow. The Russian situation was a cause for massive and widespread concern.
Between May and August, stock, bond and currency markets collapsed, severely damaging countries involved with Russia. The damage was particularly devastating to the smaller economies intertwined with Russia. Major banks failed and a moratorium was placed on payments to foreign creditors.
Shaking Out the Ruble
With the exchange rate artificially pegged, it took time to adjust. On August 17, the trading band was expanded from 5.3 - 7.1 to 6.0 - 9.5 rubles per Dollar. From August 17 to August 25, the currency depreciated from 6.43 to 7.86 and then quoting stopped. On September 2, the ruble was floated freely and, by September 21, the rate reached 21 rubles per dollar.
The major result of the crisis was that the currency was allowed to float freely, and thus could potentially dampen the effects of future crises. Russia recovered relatively quickly due to the rapid rise in oil prices seen through 1999 to 2000, and strong domestic industry which benefited from the devalued ruble.
The fallout and devaluation of the ruble was not unexpected. It was there for all the world to see, and there were speculative "attacks" on the currency starting in 1997 as the Asian crisis took hold. These traders made a lot of money, but a trader didn't need to be the first in to make money. There was ample time to get in before the currency was floated.
The 2010 euro debt crisis saw the euro decline over 20% from December of 2009 to June of 2010, as many speculators began to predict that the members of the European Union would not be able to operate under the same currency.
The crisis was largely more of a scare than an actual meltdown, and was fostered by contagion fears from Greece. Greece had a fast-growing economy from 2000 to 2007, increasing at a 4.2% annual rate, but the financial crisis in 2008 severely hurt the Greek economy. Greece was found to have massaged statistics and deliberately misreported financial figures to hide true debt levels in order to stay within monetary union guidelines. In 2009, debt estimates to GDP were at 6%, but by May of 2010, those estimates were at 13.6% - one of the highest in the world.
Europe at Risk from the Greek Contagion
The spread of the crisis in Greece to the rest of the eurozone was of prime concern. Ireland required a bail out in December of 2010, and Spain, Portugal, Belgium, Estonia and Slovenia all faced debt issues or were hard hit by the former global financial crisis. If the contagion of Greece spread, speculators thought it was questionable whether or not these countries could sustain themselves or would face the same fate as Ireland.
The euro was the whipping boy of such concerns as debt downgrades plagued the region. As a result, bonds were put under pressure in suspect or economically weak countries and the euro declined against major currencies. Bailouts occurred as multiple bills and packages were put together by local and international governments, as well as global organizations like the International Monetary Fund. Those traders who saw the problems in Greece, and realized the impact a contagion might have, began a speculative attack on Greek bonds and sold the euro short.
While there were serious concerns and issues in individual countries, the euro was back near pre-crisis by April of 2011, as the corrective measures by the European Union stabilized and increased the value of the currency.
Breaking the Pound
Black Wednesday, which took place on September 16, 1992, is infamously known as the day George Soros made US$1 billion by shorting the pound prior to the British government being forced to withdraw from the European Exchange Rate Mechanism (ERM). The ERM was a monetary and economic policy tool that would attempt to keep the pound from fluctuating more than 6% from other member currencies. Leading up to September 16, speculators and dealers sold pounds in anticipation that the pound would be unable to stay above the lower threshold set by the ERM. (Find out where the Soros trade ranks in The Greatest Currency Trades Ever Made.)
The selling of pounds was due to several factors, including an inflation rate of three times that of Germany, as well as current account deficits and budget deficits. The high interest rates, inflation and laxity in government were due to what has been called the "Lawson Boom" – named after Chancellor Nigel Lawson who fostered an environment of rapid expansion and ushered in an age of inflation. Other European countries began protesting the use of the ERM and that put additional selling pressure on the pound as Britain now had to follow a policy that it likely could not implement.
A Currency Hail-Mary
Joining the ERM was an attempt to stabilize the economy and currency of Britain by linking to non-inflationary economies such as Germany. Speculators saw this as a superficial move that didn't correct the inherent problem, so the attempts of government to hold the pound above the lower band would fail. The Treasury tried buying pounds to stabilize and prop up the falling currency, but to no avail.
Interest Rate Hikes
The government raised interest rates from 10 to 12% on September 16, but this only made pound sellers more confident Britain was in trouble. In a last ditch effort, on that same day, the government said they would raise interest rates to 15%, although this never actually took place as the announcement had little effect in supporting the fall. By that same evening, Britain announced it would leave the EMR. That September, the GBP/USD dropped by 15%. Between September and December of 1992, it fell nearly 30% in total.
Leaving the EMR changed the country, so September 16 carries a controversial second name of "Golden Wednesday," as it was the day that ushered in the possibility of economic revival. (Currency trading offers far more flexibility than other markets, but long-term success requires discipline in money management. See Forex: Money Management Matters.)
While George Soros is often the man who traders think of when the subject of "great currency raids" comes up, the trade by Andrew Krieger in the kiwi also deserves attention. Interestingly, after Krieger's raid – carried out while Krieger was employed at Bankers Trust - he went to work for George Soros because Bankers only paid him a $3 million bonus for the profits he rang up.
Krieger's shorting rampage against the kiwi occurred in 1987, after the infamous stock market crash. During this time, other traders were bidding up currencies appreciating against the USD. Krieger saw that some of these currencies were inflated, mainly the NZD, and began to short the kiwi using options. This gave him massive leverage and enabled much larger positions than would be available if he had simply been dealing in the cash markets. By Krieger's own reports, he shorted the entire money supply of New Zealand and forced the market in his direction.
Crushing the Kiwi
The massive selling pressure saw the kiwi lose more than 5% in a single day, with fluctuation up to 10% in the ensuing chaos. Krieger took an approximate $300 million gain from the trade, which is why he was so disgusted when Bankers Trust only handed him a $3 million bonus.
Things did eventually settle down, but Krieger and Bankers Trust made a lot of money by realizing that currencies, especially the kiwi, were overvalued after the 1987 stock crash. Panic from the crash had caused a short-term mis-allocation of funds that would have likely corrected on its own over time - Krieger made it happen in a very short time, and collected a handsome paycheck for doing so.
TUTORIAL: Top 10 Forex Trading Rules
There will always be times when currencies fall prey to speculative attacks, although often these attacks are simply the market (participants) indicating their dissatisfaction with what is occurring in a given economy at the time. Governments are required to be fiscally responsible and maintain a balance within the economy it governs. When central banks, treasury departments and governments fail to control and tame a situation, it becomes a crisis. Often these crises are not hard to see, but the magnitude of the problem may be shrouded. As Krieger and Soros show us, and the Euro and Ruble reiterate, when a country is facing issues, it is best to stay away from buying or wait for an opportunity to short it and make money. (This market can be treacherous for unprepared investors. Find out how to avoid the mistakes that keep FX traders from succeeding. Check out Top Reasons Forex Traders Fail.)