Commentary: Derivatives out of control

ABank of England survey out today will show how much the power of the foreign exchange markets has grown since 1989, when the last comprehensive figures said trading in London had doubled in three years to dollars 187bn a day. The six leading world centres together logged almost dollars 600bn a day. But the total is now close to dollars 1,000bn.

These enormous flows defeated John Major and may scupper the French. Nicholas Brady, the US Treasury Secretary, appeared to ask yesterday whether anything can be done to control them. An example, the cynics might argue, of shooting the messenger, in this case markets that have told governments their economic policies are unsound.

Mr Brady did not appear to be talking about old-fashioned exchange controls such as those reimposed by Spain yesterday. These restrictions on capital flows may work effectively for a time in an economy with relatively small and illiquid markets. But not only has the European Community agreed to phase out capital controls, it is also hard to see them being reimposed on economies with large, liquid currency markets. The outcome will be expensive leakages and inefficiencies.

One clue is that Mr Brady was keen on controls to break the links between futures and the stock market after the 1987 crash. Could he be thinking about the derivatives markets - options, futures, swaps, and all that?

The systemic risks of the derivatives markets are still frighteningly little understood. More to the point, the products based on derivatives generate a substantial proportion of the underlying turnover in the foreign exchange market.

A new look would at least concentrate minds on the potential shock to the system of a disaster stemming from the derivatives market. And there are ways to curb them, through regulatory and margin controls.

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