Abstract
Behavior in the forex market has to be seen against the broader trends shaping the growth, integration, and agility of international capital markets. The resources available to the private sector for taking positions in the forex market are now much larger than even those of the Group of Ten central banks. When private markets, led by the increasing financial muscle of institutional investors, reach the concerted view (rightly or wrongly) that the risk/return outlook for a particular currency has deteriorated significantly, the defending central bank could be faced with a run that could easily amount to, say, $100-200 billion or more within a week. Moreover, there is little in the factors underlying the evolution of international capital markets to suggest that the increased clout of private markets (vis-à-vis official reserves) will reverse itself in the future. Quite the contrary, international diversification is still in its adolescence, the pace of financial liberalization and innovation continues unabated in most countries, the pool of savings managed by professionals is growing (as private pension schemes supplement or replace public ones, and savings shift from the banking sector into mutual funds), and the same reforms that reduce systemic risk (such as improvements in payments and settlement systems) often also enhance the private sector’s capacity to redenominate the currency composition of its assets at short notice. For better or for worse—and, given the wide-ranging benefits of integrated capital markets, it is probably better-there is no turning back.
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