Bonds defined 67
There is plenty of evidence on how easily business reverses can sink an issuer’s credit
rating. With the exception of gilts, there is a major question whether some borrowers
will be around four or five decades later. That is the most pure sense of credit risk.
With hindsight, all of the demi-centenary issuers of the early 1990s have been buffeted
by one calamity or another, whether economic downturn, tough foreign competition,
or major legal woes. And there is no reason to believe they and others will be exempt
from future ill fortune.
3.7 A bird’s-eye view of foreign exchange risk
With fixed exchange rates, which prevailed for more than a quarter century, from the
end of the Second World War to 1971, the Type III risk mentioned in section 3.6) was
practically non-existent in regard to bonds from Group of Ten and some other enti-
ties. But since 1971 things have changed; currency exchange rates have been floated,
and this change made itself particularly felt after the oil shocks of the 1970s followed
by currency market turbulence and stagflation (stagnation and inflation) characteriz-
ing the mid-1970s to early 1980s.
Moreover, in the immediate post-war decades currency exchange operations had
in large part to do with international commerce. In 1970, the year before the col-
lapse of the fixed exchange rate system, currency exchange trading around the
world was about $12 billion a day, or less than $3 trillion a year. World trade
(imports plus exports) totaled $593 billion in 1970 – which roughly means there
was about six times more foreign exchange trading than there was actual foreign
But after President Nixon took the dollar off the gold standard, in August 1971, for-
eign exchange trading increased eight-fold in just three years, to around $100 billion
a day. Correspondingly, in the decade from 1971 to 1981, foreign exchange turnover
increased four times faster than the increase in the value of world trade, leaving the
share of international commerce in the dust.
The Federal Reserve was the first to attempt to measure the rapidly growing for-
eign exchange challenges. In 1977, it surveyed trading at 44 banks representing over
95% of all foreign exchange activity in the United States at that time. What it found
is that there was $4.8 billion in daily foreign exchange trading in America alone –
which on a yearly basis gives $1.2 trillion.
Foreign exchange volatility was significant in the 1980s, as with skyrocketing
interest rates in the United States the dollar hit all-time highs, then collapsed fol-
lowing the Plaza Athene accord. By 1992 foreign exchange trading passed the
$1 trillion a day milestone world-wide. By 2004, Swift, which links thousands of
institutions in hundreds of countries, says that the nominal money flow exceeds
$4 trillion per day.
It would be a considerable understatement to say that this is far in excess of the
merchandise trade. The latter just amounts to 3% of aforementioned figures, accord-
ing to some estimates. This means that foreign exchange is 33 times the world-wide
merchandise trade, and on a daily basis it represents more than 35% of the gross
national product (GNP) of the United States.

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