The core objective of free markets is market discovery of prices. It doesn’t matter if it is currencies, shares or commodities. Efficient markets adjust prices based on underlying fundamentals duly corrected for supply and demand.
The most difficult race to gamble on is a horse race where absolute performance doesn’t matter. It is only relative performance. When you get down to modelling a tote betting system, it is highly complex. A punter may want to back a horse (bet that it wins) or lay a horse (bet that he loses). And then you may bet for a win or bet for a place (horse comes in top three).
Stock markets in comparison are relatively straight forward. Relativity doesn’t matter. A share either goes up or down. And it is mostly based on supply and demand. And nothing else. One particular script can move independent of all others.
Currency movements have the complications of both – stock markets and horse racing. And that makes them very very complex. Economists tried to build a rationale for currency fundamentals. Dr Manmohan Singh simplified it to engineer in me by saying that look at the difference in the rate of inflation in two economies – and that should define the rate at which the currency rate of one expressed in another currency moves. Simplistically if inflation in America is 2% and that in India is 10%, then the rupee should devaluate at 8%. But then who is to determine inflation rates and what is the accuracy in measuring the same. There is a further complication – when the rupee rate vis a vis the dollar changes – it should also change vs the other currencies which may also be pegged to the dollar.
But economics has gone out of the window since quant traders took over markets. George Soros has scant regard for economics and believes that the largest punter with the most coins wins. There is unfortunately some truth to this statement.
One of the reasons the dollar reigns supreme is because there is enough quant trader money punting on any change otherwise.
China broke this monopoly recently. The yuan in more ways than one is pegged to the dollar. One can say it is a derivative of the dollar. But when the U.S. is not watching, they flex their muscle and practice a delinking. One place where they practised this well was Pakistan. The result was that the Pakistani rupee appreciated 12% vis a vis the Indian rupee.
I struggle to understand this and every single ai hallucinates on this subject. I have spoken to economists around the world and the only conclusion I have for sure is that they don’t know.
What I do know however is the mathematics of trying to control a currency. It could destroy the entity intervening. So RBI has to let go and let the rupee float. One way is to offer full convertibility which we haven’t done.
It doesn’t matter whether the rupee goes down or up. The key is to let it free float. And to get our trading partners to trade in rupees.
India is now in a position to actually do it.
