Comments on: Constitutional Court rejects appeal to lift Central Bank secrecy

By: Derryl Hermanutz

Derryl Hermanutz — Wed, 11 Jun 2014 00:21:00 +0000

I think the short answer to your last question is Yes, the brother in law can profit by trading on insider information. “Market” prices, including the fx prices of currencies, are manipulated by the opinions and policy decisions and announcements of big players like governments, central banks, and big private pools of money like commercial banks. Anybody who gets advance information about which direction a price is about to move possesses tradable information that he or his brother in law could profit from. Actually it is the consensus opinion of traders that “causes” the price to move. If “everybody knows” the colon is going to drop against the dollar, then everybody tries to trade their colones for dollars, which raises demand for dollars, and raises the colon price of dollars, which reduces the fx value of colones vs dollars. It’s a self-fulfilling prophecy: “knowing” the colon is going to lose fx value causes the actions that lower the colon’s fx value.

When central bankers express opinions or make policy statements that have fx implications for their national currency, traders immediately trade on that information, which causes the result the central bank implied. As Governor of the Bank of Canada, Mark Carney (now Governor of the Bank of England) mastered the central banker art of “jawboning”, making statements that motivate traders to act in a specific direction, to raise or lower the fx value of the national currency. Carney once moved the CDN$ an entire cent in one day simply by jawboning, without the central bank buying or selling a single CDN$. Bernanke adopted Carney’s strategy, calling it “forward guidance”. Central bankers can move fx markets just by talking, which is why central bankers shouldn’t publicize their thinking or deliberating until they decide which direction, if any, they want to move the fx value of their national currency.

If your central bankers are moral saints who never deliberately leak information to their brother in law, and if they never discuss their work over dinner and inadvertently release tradable information, then everybody has to wait for the official announcement before they can trade on central bank policy decisions. But people can and do profit from insider information, and so far humanity hasn’t figured out an effective solution to that problem.

By: Ken Morris

Ken Morris — Tue, 10 Jun 2014 22:09:00 +0000

Interesting point, and I’ll take Central Bank secrecy as a necessary evil, but my concern is that the criteria for interventions aren’t secret to everyone. With secrecy, what’s to prevent a higher up in the Centrak Bank from tipping off his brother-in-law and thereby allowing small players to reap windfalls? Is the tradeoff here between large players mauling the market and small well-connected players making a bundle?

By: Derryl Hermanutz

Derryl Hermanutz — Tue, 10 Jun 2014 16:29:00 +0000

Some people argue that central banks should not be allowed to “interfere” in currency exchange markets. Wall St banks, hedge funds, and other large pools of global money have far more firepower than Costa Rica’s central bank. I don’t hear anyone arguing that large private pools of money should not be allowed to “interfere” in currency exchange markets.

When there are players large enough to move markets all by themselves, that is called market power. The premise of “free markets” is that no player is big and rich and dominant enough to exercise market power. The conditions for a free market do not exist in currency exchange markets. Forcing central banks to publicize their intentions is the equivalent of forcing Goldman Sachs to announce its plans for currency speculation. If other speculators know which direction you plan to move the market, they can frontrun you, and the frontrunners collect all the gains by trading the currencies. If CR’s central bank announces it plans to buy dollars with colones to reduce the fx value of the colon, or buy colones with dollars to reduce the fx value of the dollar, speculators can frontrun the CB and suck millions out of CR in fx gains. With today’s free global flows of money, and giant pools of private money ever-searching for any possible arbitrage opportunity, a free market in currencies is delusory, and central bank secrecy is a necessary component of every small country’s monetary policy.