Paul Erdman - The Billion Dollar Sure Thing

“How do they do it?”

“I’ll explain. But then we had better go up to your uncle’s office. O.K.?”

“O.K.”

“Fine. Well, let’s say that I’m going to speculate on another devaluation of the dollar, and I think it’s going to happen within three months. A devaluation means that the old fixed rates—remember?—will be changed between the dollar and the Swiss franc, suddenly and overnight, and thereafter the dollar will be much cheaper in terms of Swiss francs. Right?

“Good. So our speculator comes to us and we sell, for his account, $10 million three months forward—dollars that he does not have. Selling short is the term used for this type of operation. So again we make a contract: We, General Bank of Switzerland, promise to deliver to you, Chase Manhattan, $10 million U.S. in three months. You, Chase Manhattan, promise to pay us 33.5 million Swiss francs for these dollars, upon delivery. We make a separate little agreement with our speculator, informing him that we are doing this transaction in our name, but for his account, and at his risk. O.K., let’s say that a 15 percent devaluation of the dollar takes place. Overnight the spot exchange rate would drop to, say, 2.90 to the dollar. When the three months are up, we go into the market—the spot market—and buy the $10 million which our speculator never had in the first place. This $10 million would now , after devaluation, cost us only 29 million Swiss francs. Follow me? Good. But then, literally one or two minutes later, we would present this $10 million we just bought to Chase Manhattan for delivery on that forward contract we had made with each other three months earlier. Chase, on the conditions of that agreement, would have to pay us 33.5 million Swiss francs. Right? So our friendly speculator has just made himself 4.5 million Swiss francs. Let me repeat, he presold dollars he did not have for 33.5 million Swiss francs, but the cost of these dollars, after devaluation, was only 29 million Swiss francs. Voilà. ”

“Gee.”

“Yeah, and the beauty of it is that if this speculator is a good customer of ours otherwise, he would not even have to put up any margain, or deposit, on this foreign exchange forward contract. At least as long as he had a couple of million in the bank or was known to us as a very solvent person.”

“But why not?”

“Because it’s quite obvious that a strong currency like the Swiss franc would never be devalued. It’s almost 100 percent backed by gold. Thus, it would hardly ever rise above 3.4535—the intervention point at which the Swiss government must step in. If our speculator met the worst of all possible conditions when the three months were up, he would have to cover at this rate. Then his $10 million would cost, 34.535 million francs, but he would only get 33.5 million from Chase. So he’d be out 1,035,000 francs, or about $300,000. Big clients swallow such losses without blinking an eyelash. But it is highly unlikely that such a loss would occur. What the system does is give a government guarantee to speculators, which allows him to calculate to the last penny his greatest possible loss, while on the other hand, it allows him to make enormous profits—which can be ten times larger than the maximum possible loss. That’s why speculation in foreign exchange has become such a popular sport. As one American put it to me last week, ‘It’s the best game in town.’ And that’s why we, as a bank, run very little risk when we do such transactions for our clients, even when very large numbers are involved.”

“And you say Americans can also do this?”

“Why not? Of course, lots of people think that it’s not very nice to speculate against your own currency, and in recent years it’s the dollar that has always been getting into trouble. But I’ve been told that American multinational corporations cleaned up about $3 billion profits on their foreign exchange contracts made prior to the last dollar devaluation in 1973. I guess a lot of people figure, correctly, that what’s good for General Motors must be good—period.”

“Do you also speculate for the bank, Mr. Zimmerer?”

“Well, we’re actually not supposed to talk about that. You know, then it starts that ‘gnomes of Zurich’ thing all over again. Better ask your uncle.”

“Zimmerer!” Another interruption came from across the vast trading circle.

“Foreign Trade Bank Moscow. On the Telex again. They’re offering to sell $50 million three months forward this time. Shall I give them a rate?”

“No. First, I want the positions. Tell them we’ve stopped trading for an hour. They should come back then.”

He turned back to the young lady.

“Miss Rogers, would you mind taking a chair. I have to get some figures together for your uncle. I’ll be with you in a few minutes.”

And he was. “Ready to go? I’d like to talk a lot longer to you, but I think your uncle is probably waiting for us.”

“That’s all right. I think some of this stuff is getting a little too complicated for me anyway.”

They began walking toward the door when Zimmerer took Mary’s arm. “Say, would you like to look at just one other place real quick?”

“Sure,” she replied. “What is it?”

“Well, it’s another part of our department—the gold bullion trading section.”

“Oh yes, that would be just fascinating.”

“Don’t expect to see any gold bars or anything like that.”

They entered another room. It was not nearly as large as the foreign exchange trading centre. Only three men were at telephones and three others were obviously doing clerical work.

“What’s the morning fixing?”

“74.25 an ounce.”

“How much volume this morning?”

“Quite a bit. Somebody’s stirring things up, but we don’t know who yet.”

“Well, we’ll have to stir it up a bit more. Kellermann just called me. He’s got a very big order for a private client—to buy $200 million in bullion.”

“Wow. Who is it?”

“Don’t know. A numbered account. Kellermann said he would send down the written order after lunch, but we can start now. There are no limits. Just buy at the market. But for God’s sake, be careful. We don’t want this to get around. Say, I’d like to introduce you to Mary Rogers. She’s Dr. Hofer’s niece. Maybe you could explain what this is all about.”

Zimmerer turned to one of the other traders while the explanation was going on. As usual it started with the prices chalked on a big blackboard. They indicated the so-called morning and afternoon fixings of the gold bullion price, in London and in Zurich, during the past days and weeks. The world gold bullion price is set in a most peculiar, in fact, unique, fashion. In both financial centres, at almost exactly the same time of day—ten in the morning and three in the afternoon—the world’s chief gold dealers sit down, four in Zurich and five in London, to compare the buy and sell orders which have come in prior to the meetings. Then they “fix” a price at which all the deals are made. If there is an excess demand, they bump the price up and meet the excess from their own stocks of gold. If an oversupply of sell orders results, they mark the gold price down and replenish their own inventory. They act as the middlemen in all gold transactions. And, of course, they always rig a nice spread between what they buy at and what they sell for. Often, as a result of five minutes’ work, between ten and ten-five they will make millions of dollars in profits, by just matching large buy and sell orders and taking their slice in the middle. In London it is a clan of venerable merchant banks, who control this market. Of course, Winthrop’s was one of them, and in fact, it was said that since many years they have really controlled things in the London gold pool. In Zurich it was the General Bank of Switzerland who called the shots in the gold game, due to the fact that it was they, and especially their clients, who accounted for the largest part of the volume. Not that they ever revealed what the volume of gold trading was on any day, or even during any month or year. Among themselves, the banks in London and Zurich had decided that such knowledge would contribute nothing to orderly trading, and that the speculators of the world should be protected from any unnecessary worries which might arise from their having anything better to go on than rumour. But Mary didn’t know this.