Factors which are causing Euro to be so strong against Sterling

[z109]

Cheers yoganmahew, that's a nice easy to understand explanation of shortselling.

Taking the same analogy though, I'm still not sure why selling the apartment for 200k would cause it to drop in value. I'm sure smiley probably has the answer to that one.

It doesn't - you take a bet that 'fundamental' factors will cause it to drop in price. The idea that short-sellers can affect the price of an asset simply by taking a bet is a myth. If that was the case, the favourite would always win.

Oh, and we're talking about price here, not value.

 

[Afuera]

It doesn't - you take a bet that 'fundamental' factors will cause it to drop in price. The idea that short-sellers can affect the price of an asset simply by taking a bet is a myth. If that was the case, the favourite would always win.

So my understanding wasn't wrong after all then!!! I thought there might be some hidden feature of shortselling that could bring markets down. It's been blamed for so much lately.

 

[z109]

So my understanding wasn't wrong after all then!!! I thought there might be some hidden feature of shortselling that could bring markets down. It's been blamed for so much lately.

I was thinking about this last night in bed (yes, sad, isn't it) and the only way I could think of that short-sellers could influence the price of shares is that if enough people short a particular share, it might cause some of the people who hold the share to look again at the 'fundamentals' and make sure that they are still happy with their growth/dividend assumptions. But really, they should be doing this on a continual basis.

 

[demoivre]

It doesn't - you take a bet that 'fundamental' factors will cause it to drop in price. The idea that short-sellers can affect the price of an asset simply by taking a bet is a myth. If that was the case, the favourite would always win.

Don't think George Soros would agree with you and neither would I. It was the short selling of sterling in 1992 that ultimately forced the Bank of England to withdraw the currency from the ERM and devalue it.

 

[Duke of Marmalade]

It was the short selling of sterling in 1992 that ultimately forced the Bank of England to withdraw the currency from the ERM and devalue it.

A good example of how short selling is not a cause but an effect (of a currency being overvalued). If the devaluation was an unjustified capitulation to short specs the specs would simply have changed tack and gone long forcing a revaluation etc. etc. No more were short sellers the reason for sterling's woe then than they are now.

Remember when the shorties were given the red card for playing with the banks. Hey, the banks have fallen to about a third their value since the shorties were sent off.

 

[demoivre]

No more were short sellers the reason for sterling's woe then than they are now.

Totally disagree with this. The price of a currency ie the exchange rate, is ultimately determined by demand and supply. Selling GBP in 1992 for deutschemarks as Soros ($10 bn worth ) and other speculators did pushed it's price down towards it's permissible limit in the ERM. Because there was so much selling pressure on GBP attempts by the UK authorities to raise the value of GBP through higher interest rates and buying GBP using reserves wasn't going to work - hence the decision to leave the ERM and devalue the GBP.

 

[Afuera]

Totally disagree with this. The price of a currency ie the exchange rate, is ultimately determined by demand and supply. Selling GBP in 1992 for deutschemarks as Soros ($10 bn worth ) and other speculators did pushed it's price down towards it's permissible limit in the ERM. Because there was so much selling pressure on GBP attempts by the UK authorities to raise the value of GBP through higher interest rates and buying GBP using reserves wasn't going to work - hence the decision to leave the ERM and devalue the GBP.

Wasn't the fact that the British were trying to maintain an overvalued pound sterling in 1992 the real problem though? Soros was able to sell so much sterling at such a good price because the Bank of England was buying it off him. If the BoE hadn't tried to prop the price up the real exchange rate for sterling would have been found a lot quicker and shorting would no longer have been an option for Soros et al.

Either way you look at it I think shorters are only able to win if there is an overvaluation in the first place. Do you disagree? Do you think there are shorters selling sterling, even though they think it is currently fairly priced, simply to try and move the market down? I can't imagine the typical FX trader being happy with such risk to be honest. The only reason I could think of a possible play like that being considered was if volume was low enough to limit the amount they would need to pony up. When you talk about volume at a currency desk though, you're talking serious dosh.

 

[Afuera]

Duplicate post.

 

[Sunny]

Wasn't the fact that the British were trying to maintain an overvalued pound sterling in 1992 the real problem though? Soros was able to sell so much sterling at such a good price because the Bank of England was buying it off him. If the BoE hadn't tried to prop the price up the real exchange rate for sterling would have been found a lot quicker and shorting would no longer have been an option for Soros et al.

Exactly. Soros said himself and his colleagues started laughing when the British Chancellor came out during the day and said he was going to borrow £15 billion to buy the pound as that was exactly how much Soros was willing to sell! Soros took advantage of the whole ERM situation. He could short all he likes today and he wouldn't manage to bring down the pound so its not fair to say it was short selling that caused it. It was the tool that allowed Soros take advantage of the situation but it wasn't the 'cause' of the Pounds collapse.

 

[Duke of Marmalade]

I agree with Sunny and Afuera, I think demoivre is confusing cause and effect. The following is the causal flow:

Currency is overvalued (why? trade relationships ultimately)

causes

Shorters/sellers to outnumber buyers

causes

Currency to fall

Under ERM the King Canutes tried to block the second causal flow by being unreasoned buyers.

We see that the shorters/sellers are merely the transmission mechanism, they are not the primary engine of currency relationships.

 

[smiley]

interesting debate this. All that i know is that people are shorting sterling the same way as they short lots of other things....

shorting forces the price of the currency down. Those that borrow the sterling that they sell in the market, must buy it back at some point in the future, therefore casing the price of the sterling to rise again.

Nobody here is blaming shorters for all of sterlings present weakness. Its just another factor.

All that talk by the media of shorters breaking and bringing down companies was the greatest load of rubbish. They effect the share price allright, but have absolutely NO effect on the share capital of a company.

 

[demoivre]

Either way you look at it I think shorters are only able to win if there is an overvaluation in the first place. Do you disagree? .

Yes. Valuation is subjective. An overvalued asset can still continue to rise if there is enough buying pressure just as an undervalued asset can still continue to fall if there is enough selling pressure.

 

[demoivre]

Exactly. Soros said himself and his colleagues started laughing when the British Chancellor came out during the day and said he was going to borrow £15 billion to buy the pound as that was exactly how much Soros was willing to sell! Soros took advantage of the whole ERM situation. He could short all he likes today and he wouldn't manage to bring down the pound so its not fair to say it was short selling that caused it.

He wouldn't bring the pound down now because it freely floats against the euro ie there are no set limits within which the GBP must trade. The ERM was a semi pegged system so you're comparing apples with oranges. More selling pressure than buying pressure brings price down - that's the only point I have made in this discussion.

 

[demoivre]

I agree with Sunny and Afuera, I think demoivre is confusing cause and effect. The following is the causal flow:

Currency is overvalued (why? trade relationships ultimately)

causes

Shorters/sellers to outnumber buyers

causes

Currency to fall

Under ERM the King Canutes tried to block the second causal flow by being unreasoned buyers.

We see that the shorters/sellers are merely the transmission mechanism, they are not the primary engine of currency relationships.

I'm not confused about this at all - all I have said is that selling causes price declines ( obviously more selling pressure than buying pressure ). An asset being overvalued doesn't , de facto , mean that it will be sold off and price will fall. Selling has to take place to bring the price down - it's economics 101.

 

[z109]

I'm not confused about this at all - all I have said is that selling causes price declines ( obviously more selling pressure than buying pressure ). An asset being overvalued doesn't , de facto , mean that it will be sold off and price will fall. Selling has to take place to bring the price down - it's economics 101.

Fair enough, but if short-sellers temporarily depress the value of an asset below it's 'fair' value then they will get burned when it is bought up on the other side of the dip. If you believe in efficient market theory, then an undervalued asset will always find a buyer and the price will return to value. So short-sellers would be toasted if they tried to depress the price of an asset that wasn't fundamentally over-valued.

 

[Duke of Marmalade]

Selling has to take place to bring the price down - it's economics 101.

As I say, it's what comes first? Yog has explained Economics 100 which reads as follows "if an asset is over-valued in a free and knowledgable market, sellers will outnumber buyers and vice versa."The currency markets are incredibly deep and I suggest knowledgable. Can you cite any situation where shorters, acting in consort, have forced a devaluation which was not warranted by the fundamentals?

 

[demoivre]

As I say, it's what comes first? Yog has explained Economics 100 which reads as follows "if an asset is over-valued in a free and knowledgable market, sellers will outnumber buyers and vice versa."

That is not necessarily true in the short term - sentiment drives the market. By any reasonable valuation criteria Baltimore Technology in the late nineties was overvalued at £10, more so at £20, and even more so at £30 - it still went to £135 !

The currency markets are incredibly deep and I suggest knowledgable. Can you cite any situation where shorters, acting in consort, have forced a devaluation which was not warranted by the fundamentals?

Nope but for the umpteenth time the value of any traded asset won't decline unless it is sold off. An asset being overvalued in itself doesn't cause a price fall - the selling has to take place for the price to fall .

 

[Duke of Marmalade]

Okay, demoivre, I think we all understand the mechanism, and yes the market isn't always right, but it always thinks it is right, it doesn't push prices in a direction which it thinks to be wrong so as to make a killing.

If we answer the OP with "its the sellers/shorters of sterling, stupid" it doesn't actually throw much light on the situation. The supplementary question is "why are there sellers/shorters of sterling". BTW I note this morning that the Euro has gone above 91p. The old punt is now trading at £1.16.

As I have said on many occasions since 1999 we are in the wrong currency folks, and it's getting wronger by the day.

 

[csirl]

As I have said on many occasions since 1999 we are in the wrong currency folks, and it's getting wronger by the day.

Why? Our currency is bouyant, sterling is sinking. The relative weakness of sterling is a reflection on the state of their economy and their poor decision to stay outside the eurozone. Weak currencies do you no favours - the people of Zimbabwe will confirm. All they do is drive up inflation (imported goods), drive up manufacturing costs (imported raw materials) and depress the value of companies - multinational shareholders get lower profits due to the worse exchange rate.

 

[Duke of Marmalade]

Why? Our currency is bouyant, sterling is sinking.

This is the problem, it is not our currency, its value vis a vis other currencies has negligible regard to our economy. As Davy stockbrokers say on their website - "the Central Bank would love to slash interest rates, print money and devalue the currency, but they can't".

Of course it is a wonderful thing to have a strong currency, as you describe, but only if it is warranted. But if it is not warranted something will have to give, and I am afraid that is going to be mass unemployment as the reality that we are not actually earning a 40% rise in incomes versus our nearest neighbour and largest economic partner takes its toll. Yes that is what has happened - the euro has given us a 40% rise in little over a year without any increase in productivity - on the contrary, we probably should actually have depreciated against sterling.

Latest - euro greater than 93p.