Richard Olsen’s Reactions on Critics

Why have we focused on studying the forex markets? Researching these markets is like doing research in a nuclear reactor, where basic processes can be studied in states of high energy. In such an environment it is easier to identify the forces that drive financial markets and distinguish them from random market effects.

People fail to realize the importance of forex markets to support the globalization of the "investment business." Relative to trade flows, investments across borders have increased much more dramatically. The forex markets have to be able to accommodate the demands of these international investors, who want to sell their foreign holdings at a moment's notice. Even though the forex markets have grown, the growth has been insufficient to support the requirements of an international investment community.

The introduction of electronic transaction systems has speeded up transactions in forex dramatically during the past six years. There is a side effect that has been neglected by many of the commentators. Similar to the money multiplier, there is a market liquidity multiplier. If the efficiency of the transaction system increases, then transactions are settled much more quickly. This has the effect that liquidity dries up much more rapidly than in the past.

My inference is that today's forex markets are far too small to support our globalized financial community. The effect will be erratic price movements, as we saw on 7 October 1998 with the 20% shift in the dollaryen exchange rate.

The introduction of the euro will make things worse. I think that we have to look at the euro as a merger of the European countries. Europe will thus become like one big football stadium with a strong US counterpart. The world will thus have two big football stadia. The stadia need wide roads, that is, highly liquid forex markets. Unfortunately, the new dollar euro exchange rate will not be sufficiently liquid to absorb the large shifts of capital that will occur between the dollar and the euro.

Professor Amartya Sen, who received the 1998 Nobel Prize for Economics, explained in great detail that starvation is not a problem of a lack of food, but deficiencies in the distribution system. We face a similar situation with the financial markets, where the fundamental economy is in satisfactory shape, but the allocation system, that is, the financial markets and in particular the forex markets and the balance sheets of the banks, are in deep trouble.