A currency war is a situation wherein devaluation of currency by one country is retaliated by a competitive devaluation from the other country. For instance if the United States were to devalue the dollar against the Pound Sterling and if the British retaliated with their own devaluation then the situation could be accurately described as a currency war. Devaluation is believed to cause growth in the short run. However, this growth comes at the expense of one s trading partners. Hence currency wars are also known as “beggar thy neighbor” policy!

What Happens When a Currency is Devalued ?

The devaluation of a currency has multiple effects. Usually they are considered good for the economy in the short run since they increase chances of growth. However, the growth happens at the expense of other economies. Some benefits that arise due to devaluation are as follows:

• A cheaper currency makes exports cheaper. Hence, when countries devalue their currency, they end up pricing their products attractively in the international market and as a result end up giving a major impetus to exports even if other factors such as productivity remain constant.

• A devalued currency also helps to stem imports since the goods produced by other countries tend to become more expensive as compared to domestic goods. Thus, the exports of other nations are negatively affected by currency devaluation.

• Since higher exports means higher production and therefore implies higher employment, currency devaluation seems like an effective mechanism to control unemployment in the nation. However, this ends up being an export of unemployment! This is because goods that will be exported from our country will replace goods being manufactured domestically in that economy and hence cause unemployment there. Therefore, currency devaluations do not create or extinguish unemployment, they just shift it from one country to another

• Lastly, currency devaluations can also positively impact the balance of payments as well as the balance of trade of a nation thereby solving many problems by correcting persistent macro-economic deficits.

Currency Wars: History

The modern world has faced at least two severe bouts of currency wars. They are as follows:

The first instance of a major currency war was witnessed after World War 1. Germany had basically started inflating at an unprecedented rate. They were doing so in order to be able to pay the damages due as a result of losing World War 1. However, other countries like France and Britain also followed suit. Soon these countries were following devaluations by other countries with higher devaluations of their own. This continued for a long while until Germany ended up in a hyperinflation winning the race to the bottom! Other countries like France and Britain had also inflated significantly. However, their economy did not implode like that of Germany.

The next currency wars were sparked on by the Nixon shock. This is when President Nixon took the world off the gold standard. This was done with the intent to devalue the dollar and promote employment and exports in the United States economy. This would automatically end up promoting unemployment in countries that imported American goods.

The devaluation by the United States was swiftly followed by competitive devaluation by other nations following the dollar standard. The “beggar thy neighbor” policy of currency devaluations quickly became the norm. This round of currency wars ended with speculative attacks on many currencies and raging currency crises in several parts of the world.

The Present Day Currency War

Some economists argue that we are facing a present day currency war as well. However, the war is not so blatant and competitive devaluations, if any, are not immediate and there are often diplomatic reasons provided for pursuing them.

At the present moment, over 20 central banks in the world have followed the lead of Bank of Japan and the European Central Bank and have implemented expansionary monetary policies. Countries in the Eurozone as well as Japan were reeling as their economies were not competitive and incapable of exports given their currency valuations. As a result they inflated their currencies and let the free market devalue it for them! This has led to increased exports from these nations to the United States.

At first the United States was not concerned about these devaluations. This is because the domestic demand was strong enough to absorb the excess goods supplied by these countries without adversely affecting any economic parameters. However, of late, the United States government and the Fed have started being vocal about their concerns.

The United States is now continuing its policy of quantitative easing unabated because it wants to devalue its own currency and remain competitive in a market where German and Japanese imports are becoming cheaper by the day! The modern currency war is not overt. Rather it is a covert operation.

• Japan seems to be devaluing its currency to boost its shattered domestic economy.

• The European Union is following a loose monetary policy which leads to devaluation in order to stave off the Euro crisis

• The United States is devaluing its currency by creating more dollars to protect itself from the effect of the 2008 subprime crisis

Thus, each of these nations has a pretext to inflate more and devalue its currency. However, none of this changes the fact that the modern world is in a currency war and economic growth is not happening as a result of a growing domestic economy. Rather it is a result of the beggar thy neighbor policy being followed even by the developed nations.

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In this article, we will have a closer look at some of the principles that are followed during this taxation process. Also, we will understand the laws pertaining to taxation of cryptocurrencies which are in force at the present moment.

Cryptocurrencies in Australia and Canada

The laws of Canada and Australia are somewhat similar when it comes to treatment of cryptocurrencies. Both these countries do not consider cryptocurrencies to be a real currency. This is because as per their definition legal currencies can only be issued by central banks. However, they do acknowledge the fact that it is possible to undertake transactions by offering Bitcoin as means of payment.

Since Bitcoin, (which Australia and Canada consider to be a commodity) is exchanged for other goods and services, the transaction is considered to be a barter transaction. This means from a legal point of view, these transactions are considered to be happening without the use of any currency.

In these nations, barter transactions are exempt from Goods and Services Tax (GST). As a result, transactions denominated in Bitcoin are not charged GST. This is a big loophole in the law, and Canadian and Australian governments are making an attempt to close it as soon as possible.

Cryptocurrencies in the United Kingdom

The law in the United Kingdom realizes the fact that taxation of cryptocurrencies is not a simple proposition. This is because the same cryptocurrency can be, used for end use as well as for investment purpose. Hence, taxation of cryptocurrencies needs to be done on a case by case basis by understanding the specifics.

• In some cases, the United Kingdom taxation authorities consider Bitcoin to be a highly speculative investment. As a result, they compare it with gambling. Gambling losses cannot be deducted from taxable income. Similarly, gambling gains are also not added to taxable income. Similarly, in some cases, cryptocurrencies are simply left out of the taxation ambit
• In other cases, the tax authorities check the intention of the seller. Also, the legal status of the seller is analyzed. Based on this tax analysis, experts decide whether a transaction should be a part of an individual tax or a corporate tax.
• In some cases, the United Kingdom tax authorities consider cryptocurrencies to be foreign currencies. Hence, businesses are asked to account for them accordingly and profits and losses arising because of this assumption should be booked based on principles defined under the Generally Accepted Accounting Principles (GAAP)
• The United Kingdom taxation authorities have made it clear that mining of Bitcoins, i.e., generating Bitcoins from computer operations is not considered to be an economic activity for the purposes of taxation. As a result, investors mining Bitcoins receive their gains tax-free!

The problem is that the laws created by the United Kingdom are extremely vague in nature. It gives the tax officers too much freedom. This freedom can be used to extort money from investors in the name of increasing tax compliance.

Cryptocurrencies in the United States

The Internal Revenue Service, i.e., the tax department of the United States has decided to consider Bitcoin as a property and not as an income. This has profound implications for the way it will be taxed. Firstly, people who have made huge sums of money from Bitcoin trading are breathing a sigh of relief. The highest tax rate for capital gains is 15%. This is opposed to a 25% tax that is levied on most incomes. Hence, Bitcoin millionaires will have to shell out a smaller part of their fortune as taxes.

However, the United States tax laws prohibit the set off of investment loss at a maximum of $3000 per year for individual investors. As a result, if investors have lost money in the cryptocurrency market, they cannot offset their huge loss against their income in order to reduce the tax liability. One possible way is to offset only $3000 at a time and to continue doing so for next several years. However, that does not seem to help since Bitcoin is a speculative investment and many people have lost huge sums of money. The worst part is that they will now have to pay tax on their losses!

Cryptocurrency Tax in India

Developing countries like India still do not have the framework required to tax cryptocurrencies. The Reserve Bank of India has prohibited dealings in cryptocurrencies. However, the transactions that have happened in the past could be considered as investments or profits depending upon the source. If they are considered to be investments, they will be taxed at either the short-term or the long-term rate depending on how long they have been held. If they are considered to be profits, their value is added to the income of the taxpayer which is then taxed at the relevant slab.

To sum it up, the world needs to come to a consensus when it comes to taxation of cryptocurrencies. At the present moment, different tax regimes across the world are taxing cryptocurrencies differently. The problem is that since governments have no control over cryptocurrencies, traders can simply move the money to an offshore location where the tax rate is more favorable.

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Base and Counter Currencies

In stock and bond markets one can sell their security. This means that they can convert their security into money. However, in the Forex market, one is already buying and selling money. So then how does the trading work?

Well, in the Forex markets, one buys and sells currencies simultaneously. This means that one exchanges one form of currency for another. Therefore the prices of currencies are always quoted in pairs. The price signifies the unit of the first currency that one is willing to pay for the second currency. Since the price is always quoted in terms of the first currency, it is referred to as the base currency. The other currency mentioned in the pair is the counter currency.

For example in a USD/EUR pair, the United States Dollar would be referred to as the base currency while the Euro would be called the counter currency.

Long and Short Positions

Just like the bond and stock markets, Forex markets also allow traders to take long and short positions. However, the meaning of long and short positions changes in this market. Once again this is because currencies are traded in pair. Hence, new investors get confused what happens when they go long and what does it mean to go short.

In the Forex market going long means that you buy units of the base currency and sell units of the counter currency. When one already has a long position and continues to go long, they are said to be going longer!

For example if you were to go long on the USD/EUR pair, you would have to buy the USD and sell EUR in the market.

Similarly, in the Forex market going short means that you sell units of the base currency while buying units of the counter currency. Adding to the short position is referred to as going shorter

Therefore if you were to go short on the USD/EUR pair, you would have to sell the USD while simultaneously buying the EUR.

Also, going back to a zero position from a long or short position is referred to as squaring off. If you are long, you need to sell to square off whereas if you are short, you need to buy to square off.

Bid, Ask and Spread

Forex markets are run by market makers. They provide a two way market for all currencies at all times. Therefore, they provide buy and sell quotes. The price at which they are willing to buy is always less than the price at which they are willing to sell. The difference is meant to compensate them for the risk they are taking by holding a volatile asset for an uncertain period of time.

The price at which they are willing to buy is called the bid price whereas the price at which they are willing to sell is called the ask price. The difference between the two is called the bid ask spread or sometimes it is simply referred to as the “spread”.

Lots

This term is frequently used when Forex markets derivatives are being traded. Forex market future contracts always have a fixed size. For instance, US dollar contracts may be available in multiples of $5000. Therefore every $5000 contract will be referred to as a lot. Hence, if you wish to buy USD 25,000 in the future, you will have to purchase 5 lots. Different currencies have different lot sizes available. Market makers provide more flexibility to currencies which have higher liquidity.

Pip

This is the minimum amount by which the currency quote can move. The usual pip refers to 1/10000 of the quoted currency. This means that a currency must change by at least 0.00001% for there to be an effect on the quoted prices in the Forex markets.

Pips have become a part of the Forex trader lingo. Changes in prices and even profits made are expressed in terms of pips. However, since the pip could refer to a variable amount of money, it takes some experience to understand what is being communicated.

Value Dates and Rollovers

Value date is the date at which the parties to the trade agree to settle their accounts. This means that the open positions of all derivative contracts are closed automatically on the value date. Thus contracts become more volatile when they are closer to the value date.

Also, in many cases, traders decide to rollover their contracts. This means that they decide to settle their contracts on the next value date instead of the current value date. In order to do so, both parties must agree and then also there has to be a fees paid based on the interest rate differences of both the currencies.

There are many more terms that are frequently used in the Forex market. However, those terms may refer to strategies used in the market and are therefore beyond the scope of this basic article. To sum it up, Forex trading has its own vocabulary which one must get used to.

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Catastrophe bonds are a form of ultra-high-risk debt which help insurance companies to meet their obligations even if a catastrophe takes place.

In this article, we will have a closer look at what catastrophe bonds are and how they help the insurance market to function efficiently.

What are Catastrophe Bonds?

A catastrophe bond is a contract between a sponsor (usually an insurance company) and a set of investors (usually hedge funds and other high-risk investors).

The insurance company usually takes the help of investment bankers to create a special purpose entity which is different from the insurance company. This is done to shield the investors from the risks that may arise by directly investing in the insurance company. Also, this special purpose entity is set up in a tax efficient location. This helps reduce the overall cost of issuing these bonds.

In a typical catastrophe bond issue, hedge funds and other investors buy bonds which are issued by the special purpose entity. Normally, bonds are fixed income securities with no risks. However, the return provided by catastrophe bonds varies according to risk. The nature of these bonds changes according to external circumstances.

There are some pre-defined triggers like earthquakes in Florida or Typhoons in Japan which are identified when these bonds are issued. If these triggers do not take place, then the investors continue to get their coupon payments as well as their principal payments just like other bonds. However, if these triggers are breached, then the investors are likely to lose all or part of their principal. This principle will then be given to the insurer so that they can make good on the claims that they need to pay to their customers.

Types of Catastrophe Bonds

Catastrophe bonds can be segregated based on the types of events that trigger such bonds.

• Some bonds are triggered based on the level of losses that an individual insurance company is suffering. For instance, if AIG has insured many houses in Florida and if there is a flood in Florida, AIG will suffer very high losses.

  If these losses exceed a predefined amount, let’s say $500 million, then the catastrophe loss cover would apply. Hence, if the AIG faces, $700 million in losses due to claim payments, its losses will be capped at $500 million. The balance $200 million will be reimbursed by investors of catastrophe bonds

• Some investors do not want to base their risks on the underwriting practice of a certain company. For instance, in the above example, AIG may have underwritten a disproportionately large number of risky houses. Hence, sometimes the triggers are based on average industry losses.

  For instance, if the losses being suffered by the entire insurance industry amount up to $1 billion, then the catastrophe bonds will be triggered. A pre-defined percentage is usually set up to determine the extent of losses that these investors are willing to bear in different circumstances.

What Kind of Investors Invest In Catastrophe Bonds?

As mentioned above, the returns of the catastrophe bonds are unpredictable and may vary widely. Also, the returns are based on outcomes such as weather and natural calamities which are difficult to predict in the long run.

This is the reason that catastrophe bonds are issued for short periods of time with the maximum tenure being close to three years.

Also, the interest rates paid on catastrophe bonds have to be astronomically high. This is because investors are running the risk of losing all or part of their capital. This makes catastrophe bonds riskier than equity investments, and hence the return must also be comparable to that of equity investments.

It is because of this high risk that catastrophe bonds are rated B+ or below, i.e. below investment grade by all major credit rating agencies in the world. This is the reason why only high-risk investors such as hedge funds and high net worth individuals buy these bonds.

Why Do Investors Buy These High-Risk Bonds?

Catastrophe bonds are high-risk investments. Investors do not put their money in these investments to earn returns. Instead, these bonds are more of a hedge. This is because the returns from these bonds are not correlated to other investments in the market.

The interest rates on these investments are defined as LIBOR plus certain percentage points. Hence, even if the interest rates move up or down, the real return from these bonds remains exactly the same. Also, the return of these bonds bears no relation to stock market crashes or uprisings. Hence, portfolio managers find these tools useful in order to diversify their risks.

The bottom line is that catastrophe bonds are an important part of the insurance industry. It is these bonds that let insurance risk be distributed amongst a number of individuals. In the absence of catastrophe bonds, reinsurance companies would find it difficult to remain solvent in the event of a catastrophe.

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Carry trade is a kind of trade that is peculiar to the Forex market. In other markets, traders trade with the intention of benefitting from capital appreciation. However, in case of carry trade, traders have two expectations.

They want to earn cash from capital appreciation as well as from the interest rate differentials that arise from buying or selling currency.

Since interest rate differentials are peculiar to the Forex market, so is the concept of carry trade.

It must be understood that the concept of rollovers and carry trade is in stark contrast to that of settlement. Therefore, rollovers only take place in case settlement does not. This is the reason rollover is preferred by speculators who want to avoid giving deliver of the actual underlying currency and would rather simply pay interest to avoid such a situation. In this article, we will have a look at this concept in greater detail.

Rollovers

The concept of carry trade is closely linked to the concept of rollovers. Rollover is the amount of money that an investor obtains or has to pay to hold the currency overnight i.e. through to the next trading day. Since, the Forex market operates 24 by 7, a day is considered to end at 5 PM Eastern Standard Time in most cases i.e. the money becomes due at 5 PM EST. Hence if a position is open at that time, it is considered to have been open throughout the preceding day.

The quotations for rollovers also change moment to moment. The rollovers for buying and selling currency pairs are listed along with the quotation.

A positive number denotes that the amount will be received as a result of the transaction whereas a negative number denotes that the amount will have to be paid. Also, there are separate rollovers that are quoted for buy as well as sell transactions.

Two interest rates: Currencies are always traded in pairs. Also each currency has an interest rate attached to it. Therefore, there are always two interest rates involved when Forex trading occurs.

Now, obviously if one currency has a higher interest rate than the other, one side of the trade would benefit by holding the currency.

To avoid this from happening, the side that holds the currency with the lower interest rate has to pay rollover to the counterparty so as to mitigate the effect of interest on the trade. The amount of interest received is abysmally small (say 2% per annum) in most cases.

However, since Forex trading involves placing highly leveraged bets, the amount of interest received in rollovers can have a significant impact on the profitability.

Case #1: Earning Rollover Interest

In case we buy the Eurodollar pair, this means that we buy the Euro and sell the dollar. Let s say the interest rate on the Euro is 3% and that on the dollar is 1%, then there is a 2% differential in the interest rates of the two currencies. Therefore in this case, the person holding the Euro will receive an interest credit at the rate of 2% per annum at 5 PM EST each day that the trade is open. The interest will be equivalent to Euros in terms of value.

However, generally it will be paid in US dollars regardless of the currencies being traded because of the liquidity provided by the dollar.

Case #2: Paying Rollover Interest

On the other hand, if an investor were to sell a Eurodollar pair, i.e. sell the Euro and buy the dollar and the interest rates of the respective currencies were 3% and 1%, then such a trader would face a debit equivalent to 2% annually as a result of the trade. The money debited from the account of such a trader is the one that is credited to the account of trader mentioned above. This transaction is usually a very small adjustment to the trader s account and is undertaken by the brokers automatically.

Predicting Directions and Risk

Carry trades only work when the traders are able to predict the direction of the trade correctly. For instance, if they go long on a currency pair in order to earn $5 in interest and end up losing $40 as a result of an adverse market movement, the trade would not make sense at all.

It is for this reason that carry traders need to be reasonably certain about the direction in which the trade is going to progress. They could be incorrect about the magnitude. However, the magnitude will only affect the quantum of profit that is being made. It will not end up converting a profit into a loss.

Risk Mitigation

Since carry traders have to take a large amount of risk for a small amount of interest income, they must ensure that they have adequate risk mitigation mechanisms in place. This means that they need to be aware of the exact points where they will cut their losses and exit the trade. If possible, automated stop loss or trailing stop orders should be placed to avoid operational issues during execution.

There have been entire trading houses that have built their strategies around these interest rates and carry trade. Carry trade is an effective way to trade the Forex market short term and generate cash flow. However, one needs to be cognizant of the risks as well.

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Bitcoin: An Alternative Investment Asset

Bitcoin comes into existence through mining. In common words, this means that people have to lend the processing power of their computers to process Bitcoin-related transactions. Users are then rewarded with a Satoshi which is a smaller unit of a Bitcoin.

The idea of a currency which can completely bypass the fiat currency model seems fascinating to many investors. Investors are tired of the constant inflation that government-issued currencies bring along. $1000 invested in United States dollars in 2013 would have a purchasing power of only $900 or so. On the other hand, $1000 invested in Bitcoin in 2013 would today be worth millions in 2017! Bitcoin has by far outperformed every central bank issued fiat currency.

Several investors view Bitcoin as an alternative to fiat currency. The Bitcoin algorithm has been developed to prevent inflation. The maximum amount of Bitcoin currency has been capped at 21 million.

Is Bitcoin Really a New Currency?

The short answer would be no. The long answer is a little bit more complicated. Here are the details:

• The function of money is to be able to facilitate the exchange of goods and services.

• This means that other people must be willing to accept the currency in barter transactions. It is therefore imperative that the currency has a value of its own. For instance, gold can be used in a barter transaction. The recipient of gold may decide to keep gold as it is or exchange it for other goods and services.

• Bitcoin does not have any intrinsic value. It cannot be seen or touched. It is only a digital currency and the only reason merchants accept it is because they can later exchange it for Fiat currency.

• It would, therefore, be inaccurate to say that Bitcoin is money in its right. It is just a method of using the existing money, i.e., the fiat currency. It can be compared to financial instruments like debit cards and credit cards which are also a medium of exchanging money. The most important feature of Bitcoin is that it allows people to avoid regulation. This is the real reason behind its popularity.

• Bitcoin does not serve many functions of money. It is not accepted in the payment of taxes. It cannot be used as legal tender to discharge debts.

Stability

For a currency to be useful, it must have a relatively stable value. This means that consumers must be able to exchange the same amount of currency for the same amount of goods and services. The higher this stability over a period of time, the better the currency is!

Bitcoin fails this test. The value of Bitcoin is very volatile on a day to day and even minute to minute basis. Consumers who use Bitcoin will not be able to budget their weekly or monthly expenses given the volatility that this cryptocurrency is subject to. It will be even more difficult for merchants to price their goods and services in terms of Bitcoin given the time lag between production and sales.

High Transaction Fee

A stable currency does not try to forcibly lock in its users. However, that is exactly what Bitcoin does. The transaction charges related to Bitcoin are prohibitive. At the present moment, Bitcoin users have to pay over $13 as transaction charges for every transaction! As the number of Bitcoin mined decreases, the transaction fee is likely to increase over the long term making matters worse.

This means that even if they buy a cup of coffee worth $5 with Bitcoin, they still have to pay $13 for the transaction fee. This is why Bitcoin is not a stable currency but instead a volatile investment.

Long Processing Times

Apart from being expensive, Bitcoin transactions are also inconvenient. Consumers are used to instant payments and receipts. On the other hand, Bitcoin transactions take over an hour to process. As Bitcoin is not an organized currency, you can’t really call up customer service and check the status of the transaction.

Bitcoin is not a viable alternative to fiat currencies because of the sheer inconvenience it causes. Trade and commerce would drastically reduce if every transaction took over an hour to process!

The Electricity Requirement

Bitcoin requires a huge amount of electricity. Each transaction processed by Bitcoin consumes more electricity than a United States household would consume in an entire week! This is what makes Bitcoin unviable for more than three-fourths of the world. The developing world is facing a shortage of power even for meeting daily necessities. A currency that consumes enormous amounts of electricity would simply be unviable in most parts of the world.

It would, therefore, be safe to say that at the moment, Bitcoin isn’t a practical alternative to fiat currencies. Speculators and gamblers instead of consumers lead the current Bitcoin boom.

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The world had seen many Ponzi schemes. However, this one was unique given the fact that it had been running for over two decades in one of the most regulated markets in the world. The existence of the Madoff scam made people question the existence and competence of regulatory bodies like Securities Exchange Commission (SEC).

The SEC was not able to detect this scam till the very end. It is only when Madoff’s two sons got wind of their father s illegal operations that they reported the issue to the authorities and Madoff was arrested. Madoff was later charged with financial fraud and embezzlement to which he pled guilty without trial and is today serving his 150 year sentence in prison.

Background: Madoff LLC

Bernie Madoff had started as a small time penny stock broker in the 1960’s. His claim to fame was software that was developed by his brother that could supposedly pick profitable trades within a few seconds. A lot of people invested with Madoff and made good money giving his company a good reputation. Soon Madoff LLC grew into a financial powerhouse and was the sixth largest market maker on Wall Street. Madoff became a very well respected figure on Wall Street and served on the boards of various stock exchanges as well.

Madoff had three lines of business. Apart from brokerage, he also conducted proprietary trading. However, it was the hedge fund that was the crown jewel of his empire. This was personally managed by Bernie Madoff and was the epicenter of the gigantic $50 billion embezzlement, probably the largest in world history.

The Illusion Created By Bernie Madoff

Bernie Madoff’s hedge fund was a class apart. While other hedge funds were looked upon as speculators, Madoff was looked upon as an expert money manager. Other funds had erratic returns. Sometimes they would make a lot of money and at other times they would lose a lot. This is a fundamental characteristic of hedge funds and the basic reason why only accredited investors with more than a $200000 net worth can invest in them. The average investor is kept away from hedge funds by the government because of the massive risks involved.

Bernie’s fund had been giving a consistent return of close to 12% for decades. The fund had seemingly survived many recessions and crashes. However, the record was impeccable and 12% return worked like clockwork.

People would queue up to give Bernie their money and Bernie was very selective about who he did business with. Getting Bernie Madoff to manage their money became a status symbol amongst the wealthy as Bernie’s selectiveness gave him an aura of exclusivity and created a high end brand.

The Reality of Bernie Madoff

Needless to say, the reality of the funds managed by Madoff’s hedge funds was very different than what the illusion was. Madoff had no magical way of navigating the ups and downs of the market and always creating a 12% return at the end of it. In reality, Madoff was paying off the old investors by receiving money from the new ones. This is the very definition of a Ponzi scheme i.e. financial fraud!

Madoff was very selective about his investors because he mostly managed money for large charities and non profits. These institutions were regulated by the law and had predictable withdrawal patterns. Hence, Madoff maintained a percentage between the money managed for non profits and the money managed for private individuals. This would enable him to make payments if demanded by the investors and thereby prevent a run on the fund!

Bernie Madoff’s trusted aides had set up an entire secret operation wherein they would always pay a 12% return on withdrawal or even in the annual statements. His accomplices would simply reverse engineer the trades and claim to have purchased and sold certain securities which in retrospect would make achieving this return appear very probable. An entire software unit was set up on the mysterious 17th floor of the office wherein these fabricated statements were created. Investors did not have online access to their accounts and as such could not check their statements real time.

Multiple Warning Signs

Madoff was reported on several times before the 2008 fallout. In fact, one investor had given a 21 page letter to the Boston SEC enumerating reasons as to why Madoff Investments could not be a legitimate business operation. However, surprisingly a blind eye was turned towards such complaints which were regarded as vicious attempts by jilted competitors to malign Madoff’s name.

In retrospect, Madoff’s significant influence in Washington could have played a major part in getting him off the hook multiple times. Also, Madoff’s niece was married to a senior SEC official making SEC part of the family too! However, no charges of corruption have been proven and from the public version of the tale, it seems like Madoff was simply smart enough to fend off the regulators several times and continue the Ponzi empire till it became fundamentally unsustainable in 2008.

Madoff is said to have confessed the situation to his two sons who reported it immediately to the regulators since they did not want to be part of the scandal.

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The Recognition by Governments

Most governments of the world have been in denial about the rise and popularity of cryptocurrencies. This is because cryptocurrencies take away power from the state. Right now the government has fiat powers, i.e., they can create as much money as they want. In case of cryptocurrencies like Bitcoin, the government will also have to earn money like everyone else. This puts them at a significant disadvantage.

However, the popularity of the Bitcoin has surged so much that even the governments cannot ignore it. The Japanese government was forced to recognize BitCoin. The recognition from the world’s 3rd largest economy and Asia’s largest economy has been very beneficial for the value of this currency. A large portion of the rise can be attributed to the rising demand in Asia which was a direct result of this formal recognition by the Japanese government.

The Surge in Ransomware

The entire world has been facing a ransomware epidemic as of late. Important date of several corporations has been hacked into, and payments have been demanded to release the data. The interesting that is that most of these payments have been demanded in cryptocurrencies like Bitcoin. The reason behind this is simple. It is impossible for the governments to keep track of these currencies. They can use forensic accounting and find a money trail for normal currencies. However, cryptocurrencies are immune to such investigations.

Also, cryptocurrencies like Bitcoin can be easily converted into cash from any exchange in the world. Hence, hackers can spread the money across several locations and further obscure the investigations being conducted by the government. The increase in the popularity of Bitcoin by hackers has provided bad PR to Bitcoin. However, it has raised the demand by leaps and bounds. Many corporations were forced to buy Bitcoin, and they have sent the market spiraling upward in the process.

Money Transfers

Several people in different countries of the world have started using cryptocurrencies like Bitcoin as a means to transfer money. Traditional money transfer agencies such as the Western Union are very expensive. Bitcoin is considerably cheaper. The sender of the money converts it into Bitcoin which is then digitally sent to the receiver. The receiver then converts the amount into local currency at the prevailing rate for the Bitcoin. By doing this activity, several laws can be circumvented. These include the Western Union fee, the spread for conversion of currencies and even the income tax laws in the recipient country. Governments all over the world do not have the mechanism to track the inflow of Bitcoin and hold them accountable for tax purposes. Millions of people are taking advantage of these loopholes, and the popularity of Bitcoin is rising in the process.

Illegal trade

Bitcoin has become the currency of choice for illegal businesses. Criminals dealing in arms and drugs have been using Bitcoin extensively. The reason is the same. Bitcoin cannot be easily tracked.

It is easy to store, less liable to seizures or confiscation by the government. Drug dealers can therefore easily transfer the money from one nation to another and can circumvent the money laundering regulations that have been hampering their business. Once again, this is leading to negative publicity for Bitcoin.

It has become the currency of criminals. As there are so many illegal activities happening all over the world, the demand for Bitcoin is going through the roof. As more and more anti-social elements are becoming aware of this, the demand for Bitcoin is rising.

Pitfalls of Using Bitcoin

• The Bitcoin market is not perfectly liquid. It has seen vast differences in the value of Bitcoin when different currencies are involved. For instance, the value of Bitcoin in United States dollars was more than the value of Bitcoin in Korean Won.

  In normal circumstances, traders join the market to make an arbitrage and bring the values to parity. However, that did not happen for a long time in this market. This signals the lack of liquidity which is dangerous since investors may not be able to move in and out of a Bitcoin investment when they wish to.

• Purely speculative purposes are driving the Bitcoin rally. As we can see from the article above, the surge in Bitcoin’s price is not because of its increased acceptance as a medium of exchange. Instead, it is because of Bitcoin’s use as a medium to circumvent the law. The cryptocurrency has seen similar rallies in 2011 and 2014. However, the demonstrations resulted in a crash immediately after the rally was over.

Hence it would be safe to say that the current Bitcoin boom is more of a bubble than a fundamental change. Investors would be safer if they stayed away from the bubble.

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Also, Black Wednesday was unprecedented in the fact that this was the day when open markets took on a powerful central bank with virtually unlimited access to money and the power to create more money if required and won! In this article, we will describe the events that lead to the Black Wednesday in detail.

England Joins European Exchange Rate Mechanism

The European Exchange Rate Mechanism was an exchange rate mechanism for European currencies which chose to be a part of the group. The idea was to reduce the variability of exchange rates between the European currencies. Hence, the European Exchange Rate Mechanism proposed that the currencies should be allowed to float freely. However, the range in which they float should be pre-decided. Thus, the European Exchange Rate Mechanism was a sort of a semi-pegged mechanism.

The rate of the British pound would be allowed to change in value relative to the German Deutschemark. However, this variability will only be allowed up to a certain extent. If the market took the rates beyond a given threshold, then the Central Banks would swing into action with their open market operations and ensure that the exchange rate is maintained as desired.

However, the problem was that England joined the European Exchange Rate Mechanism at an overvalued rate. This decision was taken by England unilaterally despite oppositions from German central bankers. Therefore, from the moment England joined the mechanism, there was a possibility that they could be under attack. However, the Prime Minister of England was more focused on bringing down inflation and hence continued to join the European Exchange Rate Mechanism at a higher rate despite several warnings!

Unification of Germany

The problem began in 1992 when West Germany united with East Germany. East Germany was less prosperous and therefore the cost of the unification was too high. The German economy as a whole suffered and inflation started running amok in Germany as well. To prevent this, the German central bankers changed their monetary policy.

What the Germans did was no different than what any other central banker would have done. One of the foremost responses to rising inflation is to raise interest rates. However, the problem was that the Deutschemark had become the base currency for European Exchange Rate Mechanism. All currency rates were semi-pegged to the mark. Hence by raising its own interest rates, Germany had fixed its own problem. However, it ended up creating massive problems for other member countries.

Fall of the Lira

The first casualty of the German interest rate rise was the Italian Lira. Like the British Pound, the Lira was also overvalued. The Italian economy was in dire straits and the Italian Central Bank was desperately taking action to preserve the value of the Lira.

The German Bundesbank was also required to assist Germany in this market action as per the European Exchange Rate Mechanism agreement. The German central bank did help the Italians for a while. However, when it started affecting their domestic operations, the Germans gave up sending a very dangerous signal to the speculators in the market. The speculators now knew that the Bundesbank was only co-operating with other members to a certain extent and beyond that the members were on their own.

Attack on the Sterling

The markets as well as the British had pre-empted an attack on the British pound after the lira. It is for this reason that the British government officials were regularly in talks with Bundesbank officials asking them to lower interest rates. However, the Bundesbank officials did not respond to British pleas.

Speculators who were observing these developments began buying the Deutshemark and selling the Pound in the market. This widened the exchange rate gap between the two currencies. The British Central Bank began to intervene in the market. They were buying all the currency that was being sold by speculators and as a result maintaining the prices. However, the speed at which the market was selling pounds quickly left the Forex reserves of the Bank of England depleted. As a result, the Bank had to admit defeat. It had to exit the European Exchange Rate Mechanism and lower the value of the pound!

Thus, a bunch of speculators had forced the mighty Bank of England into admitting defeat. The pound fell much below the lower threshold of the European Exchange Rate Mechanism as it continued to free float after the attack.

George Soros was one speculator who gained a lot of fame after the attack on the British Pound. “Quantum fund” i.e. the hedge fund managed by George Soros ended up making upwards of 1 billion dollars in profit from the fall of the British pound. Also, his influence over the currency markets was ascertained and he came to be known as the “man who broke the Bank of England”

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Bretton Woods

Situation: The European countries were fighting World War-2. As such the economies of the world had been destroyed. Many countries had resorted to printing money to be able to finance the humungous war expenses. Therefore, there was a looming threat that as soon as the war got over, many economies in Europe would simply implode because of the inherent instability in their currency markets. As such to prevent such an outcome from happening, all the countries in the world, with all the prominent political leaders and economists held a conference at Bretton Woods in the United States. This came to be known as the Bretton Woods conference and had huge implications on the future monetary system and evolution of the Forex market.

Objective: The objective of the conference was to create a new monetary system that could withstand the possible shocks that it would receive once the war ended. This meant that the conference was meant to create a system that would enable the nations to avoid rapid depreciation and complete fallout of their currency systems.

Arrangement

The arrangement decided at the Bretton Woods system was slightly complex as compared to the gold standard that was already in place.

• Dollar Pegged to Gold: The United States had the largest reserve of gold in the world after World War-2. According to many estimates, it had more gold than all the European economies put together. This is the reason that the United States dollar overtook the British pound sterling as the most important currency during this period.

  Since United States had most of the gold in the world, the value of the United States dollar was pegged to gold. The price was fixed at $35 for an ounce of gold. There was a Federal gold window where anybody holding a dollar bill could go to exchange it for gold.

• Peg to the Dollar: All the other currencies in the world were pegged to the dollar. This meant that if the value of the dollar changes by 5% then the value of the other currencies would also change by 5% only. There was a 1% fluctuation that was allowed between the value of the dollar and other currencies. If the difference in the value of the dollar and the value of other currencies was greater than 1% then the Central Banks were instructed to engage in open market buying and selling operations and bring the currency within the relevant range.

• Concept of Reserve Currency: The Bretton Woods system ended up making the dollar the reserve currency of the world. Since all the countries were now transacting in US dollars instead of gold, the essential commodities such as gold and oil also came to be priced in terms of US dollars instead of gold. As such, dollar became a reserve currency. This means that every country that wanted to conduct foreign trade had to hold some amount of US dollars regardless of whether or not they wanted to trade with the United States.

Institutions

Many of the stalwart economic institutions that we see today were formed as a result of the Bretton Woods agreement. Institutions like the International Monetary Fund (IMF) and the World Bank were created as a result of this agreement.

The Bretton Woods system was one of the most popular arrangements between countries to form a formal monetary system. However, it could only survive for a period of 27 years i.e. till 1971. The Bretton Woods system was officially over after the Nixon shock i.e. when the United States unilaterally took the world off the gold standard.

Smithsonian Agreement

President Nixon took the world off the gold standard in 1971. However, he was concerned that free market operations in the Foreign exchange markets would bring distress and devaluation to many currencies. Therefore, he persuaded many countries to enter into an agreement called the Smithsonian agreement. This agreement was largely a failure as it lasted for less than a couple of years and ended up in the complete suspension of the Foreign Exchange markets !

Fixed Exchange Rates: The United States persuaded the G-10 countries to enter into an agreement wherein they would keep their exchange rates pegged to the dollar. However, the dollar would not be pegged to gold. Hence, it was essentially a Bretton Woods agreement minus the gold backing. Also, Central Banks were allowed certain liberties as the value of their currencies was allowed to fluctuate to 2.5% plus or minus of the value of the dollar before their Central Banks were supposed to conduct open market operations.

US Trade Deficit

This arrangement seemed weak on paper. However, it completely crumbled under the pressure of markets in the real world. The United States trade deficit kept soaring and as a result the value of gold went up to $210 for an ounce in 1972. As a result, all the members of the G-10 abandoned the Smithsonian agreement. This ended up in the closure of the Forex markets for a while!

The failure of the governments of the world to create a system wherein the exchange rates of the currencies would be fixed and stable left no alternative other than having a market for freely floating currencies. This is the stage where we find ourselves today. The Forex market as we know today is the result of the failure of the Bretton Woods and the Smithsonian agreement.

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