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Hard currency

MONEY you can trust. A hard currency is expected to retain its value, or even benefit from APPRECIATION, against softer currencies. This makes it a popular choice for people involved in international transactions. The dollar, D-MARK, sterling and the Swiss franc each became a hard currency, if only some of the time, during the 20th century.


An ancient system of moving money based on trust. It predates western bank practices. Although it is now more associated with the Middle East, a version of hawala existed in China in the second half of the Tang dynasty (618-907), known as fei qian, or flying money. In hawala, no money moves physically between locations; nowadays it is transferred by means of a telephone call or fax between dealers in different countries. No legal contracts are involved, and recipients are given only a code number or simple token, such as a low-value banknote torn in half, to prove that money is due. Over time, transactions in opposite directions cancel each other out, so physical movement is minimised. Trust is the only capital that the dealers have. With it, the users of hawala have a worldwide money-transmission service that is cheap, fast and free of bureaucracy.

From a government's point of view, however, informal money networks are threatening, since they lie outside official channels that are regulated and taxed. They fear they are used by criminals, including terrorists. Although this is probably true, by far the main users of hawala networks are overseas workers, who do not trust official money transfer methods or cannot afford them, remitting earnings to their families.

Hayek, Friedrich

An influential economist of the Austrian school, who won the NOBEL PRIZE FOR ECONOMICS in 1974 for his theory of the BUSINESS CYCLE many years after this body of work seemed to have been disproved by KEYNES. Born in 1899, Hayek attended his home-town University of Vienna after the first world war. He was attracted to SOCIALISM until he read a pioneering Austrian economist, Ludwig von Mises, on the subject, after which, he said, 'the world was never the same again'.

Hayek argued that the business cycle originated from expanded CREDIT CREATION by BANKS, which was followed by FIRMS and people making mistaken CAPITAL investments in producing things for which the market turns out to be smaller (or larger) than expected. But after an initially enthusiastic reception, the Austrian business-cycle theory lost out in policy debates to Keynes's General Theory. After the second world war, Hayek was a leading member of the CHICAGO SCHOOL along with Milton FRIEDMAN, among others.

Hayek was a noted proponent of the free-market system and a critic of state planning. His 1944 book, The Road to Serfdom, anticipated the demise of command economies that sought to suppress PRICE signals. This prediction came from his belief in the limits of human reason and has faith in the superior ability of CAPITALISM to make efficient use of limited INFORMATION and to learn by trial and error. His views, which echo Adam SMITH's INVISIBLE HAND, are said to have inspired the free-market economic reforms undertaken in the 1980s by Margaret Thatcher and Ronald Reagan. He died in 1992.


Reducing your risks. Hedging involves deliberately taking on a new RISK that offsets an existing one, such as your exposure to an adverse change in an EXCHANGE RATE, INTEREST RATE or COMMODITY PRICE. Imagine, for example, that you are British and you are to be paid $1m in three months' time. You are worried that the dollar may have fallen in value by then, thus reducing the number of pounds you will be able to convert the $1m into. You can hedge away that currency risk by buying $1m of pounds at the current exchange rate (in effect) in the futures market. Hedging is most often done by commodity producers and traders, financial institutions and, increasingly, by ­non-financial FIRMS.

It used to be fashionable for firms to hedge by following a policy of DIVERSIFICATION. More recently, firms have hedged using financial instruments and DERIVATIVES. Another popular strategy is to use 'natural' hedges wherever possible. For example, if a company is setting up a factory in a particular country, it might finance it by borrowing in the currency of that country. An extension of this idea is operational hedging, for example, relocating production facilities to get a better match of costs in a given currency to revenue.

Hedging sounds prudent, but some economists reckon that firms should not do it because it reduces their value to shareholders. In the 1950s, two economists, Merton Miller (1923-2000) and Franco Modigliani, argued that firms make MONEY only if they make good investments, the kind that increase their operating cashflow. Whether these investments are financed through DEBT, EQUITY or retained earnings is irrelevant. Different methods of financing simply determine how a firm's value is divided between its various sorts of investors (for example, shareholders or bondholders), not the value itself. This surprising insight helped win each of them a Nobel prize. If they are right, there are big implications for hedging. If methods of financing and the character of financial risks do not matter, managing them is pointless. It cannot add to the firm's value; on the contrary, as hedging does not come free, doing it might actually lower that value. Moreover, argued Messrs Miller and Modigliani, if investors want to avoid the financial risks attached to holding SHARES in a firm, they can diversify their portfolio of shareholdings. Firms need not manage their financial risks; investors can do it for themselves. Few managers agree.

Hedge funds

These bogey-men of the FINANCIAL MARKETS are often blamed, usually unfairly, when things go wrong. There is no simple definition of a hedge fund (few of them actually HEDGE). But they all aim to maximise their absolute returns rather than relative ones; that is, they concentrate on making as much MONEY as possible, not (like many mutual funds) simply on outperforming an index. Although they are often accused of disrupting financial markets by their SPECULATION, their willingness to bet against the herd of other investors may push security prices closer to their true fundamental values, not away.