Explaining the October Flash Crash in the British Pound
We all know that software is eating the world.
For better or worse, that statement applies to the financial world as well. It is said today that 75% of all financial market volume is automated, though there are lower and higher estimates out there depending on the report.
The bottom line is that algorithmic trading is the dominant market player – and this has benefits and drawbacks for average investors. On the upside, markets are less volatile and presumably more rational because they are driven by computers instead of fallible humans.
On the other hand? Sometimes algos just go rogue and do something unpredictable.
When the British pound flash crashed earlier this month, it was exactly this latter thing that happened.
Explaining the October Flash Crash in the British Pound
The following infographic from Top 10 Forex VPS shares a play-by-play breakdown of how the British pound crashed a whopping 8% in just two minutes.
It’s interesting because it helps give a sense of how the piping works behind these trading algorithms. It’s also a cautionary tale of algos gone wild, showing how market momentum can be swung in a particular direction even without your average market participants being involved.
In the aftermath of Brexit, the British pound has subsequently morphed into a “political” currency that seems to get most of its trading action based on commentary and speculation about the country’s eventual withdrawal from the EU.
On October 6, 2016, François Hollande said that the UK must “pay the price” for Brexit. Trading algorithms reacted to this news that they deemed to be negative, and it triggered a GBP selloff. Once a massive knock-out option was opened and a certain price broke, it triggered a number of automated stop-loss sellers.
After a few other algorithms kicked in, the British pound went from $1.26 to $1.1491 in a matter of just two minutes in USD terms. That’s a 8% slide in a globally significant currency.
Just 30 minutes later, the pound recovered to more normal trading levels.
The flash crash was just that – temporary. However, this does raise the question: what could have happened in a more extreme case of algos gone wild?
De-Dollarization: Countries Seeking Alternatives to the U.S. Dollar
The U.S. dollar is the dominant currency in the global financial system, but some countries are following the trend of de-dollarization.
De-Dollarization: Countries Seeking Alternatives to U.S. Dollar
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The U.S. dollar has dominated global trade and capital flows over many decades.
However, many nations are looking for alternatives to the greenback to reduce their dependence on the United States.
This graphic catalogs the rise of the U.S. dollar as the dominant international reserve currency, and the recent efforts by various nations to de-dollarize and reduce their dependence on the U.S. financial system.
The Dollar Dominance
The United States became, almost overnight, the leading financial power after World War I. The country entered the war only in 1917 and emerged far stronger than its European counterparts.
As a result, the dollar began to displace the pound sterling as the international reserve currency and the U.S. also became a significant recipient of wartime gold inflows.
The dollar then gained a greater role in 1944, when 44 countries signed the Bretton Woods Agreement, creating a collective international currency exchange regime pegged to the U.S. dollar which was, in turn, pegged to the price of gold.
By the late 1960s, European and Japanese exports became more competitive with U.S. exports. There was a large supply of dollars around the world, making it difficult to back dollars with gold. President Nixon ceased the direct convertibility of U.S. dollars to gold in 1971. This ended both the gold standard and the limit on the amount of currency that could be printed.
Although it has remained the international reserve currency, the U.S. dollar has increasingly lost its purchasing power since then.
Russia and China’s Steps Towards De-Dollarization
Concerned about America’s dominance over the global financial system and the country’s ability to ‘weaponize’ it, other nations have been testing alternatives to reduce the dollar’s hegemony.
As the United States and other Western nations imposed economic sanctions against Russia in response to its invasion of Ukraine, Moscow and the Chinese government have been teaming up to reduce reliance on the dollar and to establish cooperation between their financial systems.
Since the invasion in 2022, the ruble-yuan trade has increased eighty-fold. Russia and Iran are also working together to launch a cryptocurrency backed by gold, according to Russian news agency Vedmosti.
In addition, central banks (especially Russia’s and China’s) have bought gold at the fastest pace since 1967 as countries move to diversify their reserves away from the dollar.
How Other Countries are Reducing Dollar Dependence
De-dollarization it’s a theme in other parts of the world:
- In recent months, Brazil and Argentina have discussed the creation of a common currency for the two largest economies in South America.
- In a conference in Singapore in January, multiple former Southeast Asian officials spoke about de-dollarization efforts underway.
- The UAE and India are in talks to use rupees to trade non-oil commodities in a shift away from the dollar, according to Reuters.
- For the first time in 48 years, Saudi Arabia said that the oil-rich nation is open to trading in currencies besides the U.S. dollar.
Despite these movements, few expect to see the end of the dollar’s global sovereign status anytime soon. Currently, central banks still hold about 60% of their foreign exchange reserves in dollars.
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