No matter where you go in the world, if you want to buy something it is inevitable money will have to change hands.
And in an increasingly globalised system where trade is often conducted regardless of borders, it has become more important than ever to ensure you have the right currency.
This has led to a booming industry for those dealing in foreign exchange, with London acting as the global centre for the trade, handling £1.71 trillion of transactions per day during the first six months of last year.
But it is not confined to the City, with Tunbridge Wells-based firm Capital Currencies annually handling over £75million in trades per year on behalf of its 800 clients.
Although founder Craig Strong admits this is a ‘drop in the ocean’ compared to the sheer volume of London, it is achieved by just three traders in a firm numbering ten people.
For the world’s major currencies, Sterling, Dollar, Yen and Euro, there is always enough demand for a buyer or seller to be found.
However, when a currency is being traded there is a discrepancy between the bid price (what it will be bought for) and the offer price (what it is being sold for), leaving it to intermediaries, such as Capital Currencies, to act as the broker for the transaction.
They in turn make money on the difference between the two prices, called a spread, by buying the currency at the offer price and selling it on to their clients as close to the bid price as possible.
Mr Strong explains: “We have a system which we can dive into giving us real time feeds from the London market showing us what the bid and offer prices are down to the second.
“When you look at Bloomberg or the BBC, what they are displaying is a medium price with a 15-minute delay.
“So it is indicative but not an exact representation of the market at present.”
Mr Strong – who was a currency broker in the City before setting up Capital Currencies 12 years ago – says understanding this is important, because if a client asks to buy dollars at $1.43 per pound due to what they have seen on the BBC they are not going to get that for £500.
“For £5million you are going to be nearer to what you want, and for £50million you will be right up there,” he says.
This is because economies of scale are a big factor in trades, as the spread can be as tight as going down several decimal places if the volumes are big enough.
Therefore the $1.43 per pound displayed by the BBC is the result of extremely narrow spreads brought about by trillions of pounds worth of transactions each day.
Volatility
By comparison, a £500 deal will have a much larger spread as less money can be made off it, so the client wanting this transaction is likely to get significantly less dollars for their money than what is displayed.
Mr Strong says: “We don’t mind if people want to make these transactions, we do anything from £50 to the millions, but you won’t get the BBC rate at all, although working directly through us it will still be better than at the bank.
“On a million-pound transaction with us you are looking at saving around £9,000 on the bank. They are not specialists in foreign exchange, they just want to make the money and move on.”
However, the exchange rate is far from a sure bet, fluctuating every second of the day as well as rising and falling more broadly over longer periods of time.
There are two main drivers behind this volatility, macro-economics and day-to-day demand, says Mr Strong.
“Foreign exchange acts like a pool, with each big player sitting next to it with a rod. You have Citi, Barclays, HSBC, hedge funds and every other person who needs access to this pool, including us.
“You have macro-economics, this is figures released, budgets, central bank interest rates, quantitative easing and things like Brexit.
“So if Mark Carney, the Governor of the Bank of England, says rates are going to rise, this acts like a signal to buy the pound, meaning it will get stronger.
“But if economic figures then come out showing the UK economy slowing, those around the pool will go ‘this is not looking so great’ and all of a sudden the pound gets sold.
“This is what moves markets in a macro sense over longer periods of time.
“Then there are the immediate needs of each player around the pool. They each have their lines in the pool acting on behalf of their own customers.
“Each communicating with each other, buying and selling to one another, hedge funds taking positions, people dumping currencies.
“This is what makes it very choppy on a second-by-second basis, trillions upon trillions of transactions.
“Even if Capital Currencies made a £20million transaction, it would never be felt. It would be just a drop in the ocean.”
What may appear a tiny shift in the rate could mean a client loses or gains thousands of pounds on each transaction.
Therefore some companies which do regular transactions choose to hedge their positions to ensure they are less exposed to any volatility.
Mr Strong adds: “Say there is a client wanting to buy at $1.40 per pound, as anything less will cost them money on their profit margins, and that is the going rate at the time.
“We would then forward-buy all their transactions at that rate so they have no risk on currency for the rest of the year.
“If Sterling bombs, they don’t need to care as they are locked in, but if they had left the option open and it fell to $1.25, then they really would be suffering.”
Of course, it cuts both ways, explains Mr Strong, as any appreciation in the pound in this scenario would mean the client has locked themselves into an unfavourable rate.
“There is no right or wrong answer.”
In Mr Strong’s opinion, attempting to forecast the currency markets with any certainty is an impossible task, adding he would be retired by now if he could.
But there are certain developments Mr Strong says are impacting the currency markets.
“The US Federal Reserve have just raised rates. Personally I don’t think they should have done. In fact, in the UK we are now talking about if we should go negative and follow Japan.”
Negative interest rates effectively mean people end up regularly paying to keep their money deposited, as opposed to gaining a small amount of interest.
The reason behind a negative rate is to stimulate the economy by ensuring it is unattractive for people to put money aside, meaning they either spend it and boost consumption, or invest it in search of yield.
Bubbles
Borrowing becomes cheaper and it weakens currencies by making them less attractive for speculators searching for a return, helping to ensure more competitive exports.
However, ‘loose’ monetary policy makes it more likely bubbles build up in the markets which can sometimes be devastating when they burst, and weak currencies make imports more expensive.
Mr Strong adds: “The economic recovery in the UK is not bad, but it’s not great, and in my view we are not out of the woods yet.
“The Bank of England say interest rates will be going up in 2017, but my personal view is they won’t. If anything they will be held at 0.5 per cent, or even cut to 0.25 per cent.”
He also thinks a Brexit will have a huge impact on the foreign exchange market.
“It will be carnage,” he says. “There will be an increase in volatility, rumours and speculation, but it is unprecedented, so all I can do is guess.
“Sterling could devalue overnight, but there will be a run on the pound for sure by the speculators before a rebalancing.
“But sooner or later something else will happen in the world and the market focus will shift on to that.”
However, there are potential positives for Capital Currencies, believes Mr Strong.
“If we could get rid of some of the pointless EU directives that would be fabulous, and make our own sensible ones for our own banking and financial markets – that would be good.
“I don’t think you need to be ‘in it’ to be compliant with their regulations. We are not part of the US but we have to follow some of theirs.
“Personally, on a selfish basis, I think leaving will be good for business.”
