“So it’s a lot like the stock market: rich guys gambling with other people’s money,” Storm said.
“Yes, but there’s an important difference,” Click said. “The FX is not a regulated exchange. Every deal is essentially done on a handshake, or a virtual handshake. There’s no government watching over it, no special clearing house, no rules about the size of the trades, no one watching out for insider traders, no safeguards put in place to prevent large swings in the market. The New York Stock Exchange suspends trading if stock prices are dropping too far too fast or if there’s some kind of disruption in the markets that everyone needs to stop and digest. Not so with FX. It is open twenty-four hours during business days. If traders choose to bail on a certain currency, its value can — at least in theory — drop to zero, and no one will stop it. It’s a marketplace that relies solely on market forces for regulation.”
“Sounds like the Wild West,” Storm said.
“More than you know,” Click said. “Because another key principle is this: All major currencies in the world today are what we call fiat currencies. They’re not backed by any gold or silver or other commodities. They have value because the government that issues the currency says it has value, and the marketplace chooses to agree with it because the economy supporting the currency is fundamentally sound.”
Storm shook his head. “So it’s all based on shared faith.”
“Exactly. Especially with the U.S. dollar. A certain percentage of the value of our money comes from the fact that we’re considered the one unassailable currency — the too-big-to-fail currency. If you’re an international investor and you have a pile of money sitting somewhere, chances are you’re going to have it there in U.S. dollars. But economists have always speculated about what would happen if that stopped being the case.
“Now, bear that in mind when I tell you about October 2, 2008,” Click said. “If you think back to what was happening then, the financial world had pretty much gone haywire. Lehman Brothers had failed. Fannie and Freddie were teetering. AIG was about to collapse. Banks were petrified to lend each other money. There were runs on mutual funds. People were selling their entire portfolios and burying the cash in the backyard. It was a wild time, and pretty much every other day brought some news that no one ever thought they’d see. I think that’s why what happened on October 2 didn’t get much attention. Well, that, and it was over so quickly. The mainstream media didn’t even have time to understand it.”
“Understand what?” Storm asked. He realized he had scooted to the edge of his chair. Click, likewise, had leaned forward, so that his large body was smothering the edge of his desk.
“For about twelve minutes on October 2, 2008, the U.S. dollar lost roughly fifty percent of its value,” Click said, with all due drama.
“But… but wouldn’t that be impossible?”
“You would think so. You would have thought it was impossible for GM to go bankrupt, but that happened, too. Like I said, it was a wild time.”
“So what happened?” Storm asked.
“Well, that’s the question I have spent the last four years researching,” Click said. “The short version is that one of the most active and largest currency traders in South Korea decided he was done with the U.S. dollar. It wasn’t a particularly rational decision on his part. But, mind you, the Koreans were watching everything going on with the U.S. economy with disgust. They saw it as our lack of financial discipline over many years finally coming back to haunt us. So this guy essentially just cashed out and moved all his money into other currencies.”
“But… I mean, how many dollars are in circulation in the world?” Storm asked. “One person couldn’t possibly make that big a difference.”
“To answer your question, it depends how you define what ‘in circulation’ means. For sake of conversation, let’s just call it ten trillion. So, no, you wouldn’t think one investor, no matter how rich, would matter that much. But it turns out he did what’s called a double-back trade. I’m not sure I could explain the mechanism in a way that would make sense to you — no offense. Suffice it to say, it’s a trade whose impact on the value of the currency involved is not just double. It’s more like quadruple. And it was a huge trade to start with. It ended up triggering a classic negative feedback loop — a trend that started feeding on itself. Most of the trades were being done by computers that had been programmed to make certain moves when a preset value threshold was breached. The major stock markets around the world have checks against that sort of thing getting too far out of control. But, again, FX is an unregulated market. So there was nothing to stop these computers from doing their thing, and for twelve minutes, the value of the U.S. dollar collapsed in a way no one could have ever imagined.”
“But you said it only lasted for twelve minutes. Why?” Storm asked.
“Someone at the Fed saw what was happening, and the Fed swooped in and saved it. One of the ways the Fed controls monetary supply is through a big stockpile of government bonds it owns. It quickly sold a whole bunch of them for bargain prices to banks that recognized what a good deal they were getting. The Fed lost a pile of money, but in doing so it took a whole bunch of money out of circulation. From there, simple supply and demand took over. Supply had been constricted. Fewer greenbacks available made them more valuable, the negative feedback loops reversed themselves, and the dollar bounced back to what it had been twelve minutes before. To the media, it looked like one more bail-out from Uncle Sam, and one that they couldn’t argue with. So it was sort of a nonstory.”
“Okay, so…” Storm said, then turned to Xi Bang. “I’m sorry, what does this have to do with four dead bankers?”
“Well, I can show you if you like,” Click said, hefting himself out from behind his desk. “Come with me.”
Storm and Xi Bang followed click down a hallway, into a stairwell, then down some steps into the basement. Click turned into a room with several towers of servers, most of them at least as tall as he was. He sauntered up to one of them that had a keyboard and monitor built into the middle.
“Sorry to make you walk,” Click said. “I could access this from my desktop, but it takes forever to load, and I already have the model running down here.”
“I think I can handle the exercise,” Storm assured him.
“What you’re about to see in operation is the ISSMDM, the Iowa State Sudden Monetary Depreciation Model.”
“Everyone in the discipline now calls it ‘the Click Theory,’ ” Xi Bang interjected.
“Yes, well…,” Click said, as if all the attention from the enormous world of quantitative economics embarrassed him. He fiddled with the keyboard, then brought up a screen filled with numbers. “Now, bear in mind, this is a computer model of the FX. It’s a re-creation of reality, but it’s one I’ve spent four years perfecting. It allows me to predict the impact of a trade within a ninety-nine percent confidence interval.”
“Okay, so what am I looking at here?” Storm asked.
Click jabbed a finger at the screen, to a column of numbers expressed to the fifth decimal place. “There’s the value of the U.S. dollar relative to a variety of currencies in current market conditions. There’s the euro, the Swissie, the Aussie, the loonie, etcetera. I’ve just put ten up there right now, but obviously I can show you any currency you’d like to see. Here’s what happens to the value of the U.S. dollar when you sell a yard of greenbacks for, say, British pounds.”
“A yard?”
“Sorry. That’s FX slang for a billion.”
“The trades are really that large?”
“Some of them, yes,” Click said. “You have to recall, a lot of these trades are only making money way out on the margins, and only in very small percentages. So you need to make very large trades in order for it to be worth your time. So, anyhow, here’s what happens when I sell a yard of dollars.”