You may have heard of billionaire currency trader George Soros. It just so happens that he’s at the center of a controversy involving his friend, tenant and now business partner, Mark Malloch Brown. I'll tell you more about all that in a moment.
But first, a question about George Soros and his occupation. The hedge fund he created in 1969, The Quantum Fund, does much more than just trade currency. Still, he has made his mark with some spectacular currency trades.
So how does one make billions of dollars trading currency? Clearly, it’s not easy, or everyone would be doing it. But how is it done?
Before we can answer that one, we have to ask a simple question about currency itself: What is money? The answer seems so obvious that most of us never stop to ask the question. We use money every day. We buy things with it. We store it in bank accounts. And if we’re smart (and/or lucky), we make money off our investments. But what exactly is money? What does it represent?
If you look at a dollar bill, you’ll see a couple of signatures by two people who work for you: The Secretary of the U.S. Treasury and the Treasurer of the U.S. (I know, it sounds like a redundancy, but you know how the government loves to double-up bureaucrats).
Those signatures make that dollar bill a contract. The representatives of the Treasury are promising that the bills on which they put their signatures will hold their value; that the money you earn today should be worth about the same tomorrow, or even next year. But the Treasury can’t keep its part of the bargain without the help of the Federal Reserve Board.
The Federal Reserve Board (another organization of questionable value) makes all kinds of arrangements with banks to make sure that the costs affiliated with moving all the cash around doesn’t change the long-term value of the bills in your pocket. One of the mechanisms they use to affect the value of the dollar is to change the interest rates that banks charge each other for cash loans. The Fed can also use some of its reserve funds to buy up dollars or its own bonds in order to maintain the dollar’s value.
Of course, like all the best laid plans of mice and men, these mechanisms don’t always work. The value of the dollar does change.
In the 1970s, high inflation meant that the dollars you earned one day were worth a lot less a year later. That was primarily because the U.S. Treasury was printing much more money than it earned in taxes or bond sales to pay for LBJ’s Great Society programs and the Vietnam War. And all those extra dollars meant that each individual dollar was worth less. Smart economists like Milton Friedman warned that it would all end up as inflation, and he was right.
It took a tough anti-inflation guy like Fed Chairman Paul Volker to put the brakes on the money printing machines in the early 1980s. That created a severe recession, which fortunately was relieved by the Reagan tax cuts. The tax cuts gave incentives for individuals and companies to expand, which they did for seven fat years of economic growth.
Now, this is what happens when markets and economic policy are relatively orderly. In a less orderly, less rule-abiding country (like most of the countries in the world), the value of money can fluctuate wildly. Central banks in these countries are much more accommodating to political interests. They often manipulate the value of local currency to suit their political or even personal interests.
The very rich in those countries aren’t particularly bothered, because they keep most of their money in dollars and gold. And sometimes they’re in on the deal. That is, they get inside information (depending on whom they know and how much they pay) about which way the currency is about to go before it goes there.
The folks who are ruined under these conditions are the poor and middle class. Their savings (if they have any) are denominated in local currency, so if that currency is devalued they are wiped out. Devaluation also increases the price individuals must pay for goods, even though salaries usually stay the same. The currency manipulation game hurts those who can least afford it.
This is the environment within which currency traders operate. Their bets on currency are made with many things in mind—the state of the local economy, trade relations, political stability, etc. But the most valuable weapon in a currency trader’s arsenal is inside information; finding out what a central bank or government is going to do with a currency before that decision is announced to the world. That’s like seeing the other poker player’s cards before you place your bet.
Where does one go for that kind of information? There are a lot of “clubs” within which powerful people met to discuss such things. Some are formal institutions, like the Council on Foreign Relations, or other such think tanks. But some meetings are far less formal, such as a luncheon at then-UN Ambassador Madeline Albright’s New York apartment, where I first met George Soros and we casually discussed Venezuela and its currency over cocktails before lunch.
Of all these meetings however, perhaps none offer a better location to get the lowdown on currencies than a place called the World Bank. A source inside the World Bank would amount to the center jewel in any currency trader’s crown.
Compared to any international commercial bank, the World Bank’s portfolio is miniscule. But there is practically no country on the planet that has not had some dealing with the World Bank. Central bank officers, those with inside information about whether and by how much a currency might be revalued, are constantly visiting with World Bank officers. And as human encounters go, there are very useful tidbits of information that pass from lips to ears during such encounters.
That’s why when the Wall Street Journal suggested that George Soros was trying to help his friend Mark Malloch Brown get on the inside track as the new head of the World Bank it seemed to make sense.
Of course, there’s no way of proving this, and Mr. Malloch Brown denied in a letter to the Journal that he is vying for the job. But if he ever did became privy to all the information that a World Bank president has at his disposal, his relationship with his close friend (he actually lives on part of Mr. Soros’ property) and business partner would undoubtedly be a subject for many more questions.
There’s no telling exactly who will replace Paul Wolfowitz as president of the World Bank. Frankly, there are more important issues at hand, like utility of the World Bank in light of a series of terrible loans adding up to billions of dollars of losses, much of which is paid for by U.S. taxpayers. The so-called scandal involving Mr. Wolfowitz—whose “crime” was that he followed the World Bank's board of executive directors’ advice about how to handle his girlfriend’s job—pales in comparison to the misallocation and mismanagement at the Bank, which Mr. Wolfowitz was trying to turn around.
Perhaps someone with Mr. Malloch Brown’s experience could indeed tackle those problems with success. But the one thing sharpened by Mr. Wolfowitz’s experience is that friends and relations of World Bank presidents are now a legitimate subject for inquiry.
Mr. Malloch Brown’s partnership with Mr. Soros would undoubtedly come under greater scrutiny were he to present himself as a candidate for the job.
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David Asman is the host of "Forbes on FOX" which airs on the FOX News Channel, Saturdays at 11 a.m. ET.