If You’re So Smart: The Currency Trading Record of John Maynard Keynes
London School of Economics
Cambridge Judge Business School
This paper provides the first micro-study of the risks and returns to currency speculation during the 1920s and 1930s. Relying on archival research, we analyze in detail the trading record of one prominent currency speculator of this period: John Maynard Keynes. Our analysis reveals that John Maynard Keynes used his knowledge of macroeconomics and the international financial and political scene to speculate in foreign exchange markets. His trading strategy was based on a sophisticated analysis of macroeconomic fundamentals in contrast to the simple rules-based strategies characteristic of modern currency markets, namely, the carry trade and momentum. We find that John Maynard Keynes’s risk-adjusted returns were low compared to those on UK stocks and bonds and on the simple carry and momentum strategies. Whilst he exhibited some skill in forecasting the direction of currencies, Keynes found great difficulty in timing his trades. Overall, our findings indicate that Keynes’s economic expertise was of little benefit for speculating in currencies.
If You’re So Smart: The Currency Trading Record of John Maynard Keynes – Introduction
The interwar period was the most turbulent in the history of currency markets. The floating exchange rate era of the 1920s was marked by unprecedented foreign exchange volatility and the large depreciation of European currencies, whilst the 1930s are remembered for the successive waves of speculative attacks, which eventually brought down the gold standard system (Eichengreen, 1992). The interwar years also witnessed a major transformation in the practice of foreign exchange trading with the spread of dealings by telegraphic transfer and of the use of forward contracts. A large-scale spot and forward exchange market emerged for the first time in London. Anecdotal evidence from contemporaries suggests that currency trading became a substantial activity starting in the 1920s, as speculators sought to exploit the new profit opportunities associated with floating exchange rates (Einzig, 1937). However, whilst the literature on the causes and consequences of interwar currency instability is prolific, little is known about the risks and returns and the nature of speculating in currencies during this period.
This paper looks at interwar currency markets from an investor perspective and provides the first micro-study of the returns to currency speculation during the 1920s and 1930s. We ask two main questions. First, how profitable was currency speculation during the interwar period and what trading strategies were pursued? Second, we consider more generally what is the value of economic expertise in foreign exchange markets? The uncertainty surrounding the foreign exchange market and choice of regime make the interwar years a particularly intriguing background against which to examine this question.
Our analysis is based on a unique and previously unexploited source: the trading record of one prominent speculator of this period: John Maynard Keynes. John Maynard Keynes’s contributions to exchange rate theory and his writings on exchange rate policy are well known to economists and economic historians. Less well known is that he was also an active currency trader (Moggridge, 1992, Skidelsky, 1992). Between August 1919 and May 1927, and again between October 1932 and August 1939, he made full use of the newly-emerged forward market to bet on the evolution of spot exchange rates. John Maynard Keynes’s trading record provides invaluable insights into the practice of foreign exchange trading at the very onset of modern currency markets. Although anecdotes about his speculative activities abound in the historical literature, this paper is the first to analyze his trading record in detail and in its entirety. Drawing upon archival research and compiling a comprehensive dataset of John Maynard Keynes’s trades, we first describe his approach to currency speculation and explore the motivations behind his currency trading decisions. We then proceed to analyze John Maynard Keynes’s currency trading performance. Using a hand-collected dataset of month-end spot and forward bid and ask quotations for all major currencies of the period, we benchmark his returns against the risk-adjusted returns available from other assets, stocks and bonds, as well as against two alternative naive currency strategies whose performance has been widely documented in the modern period. The two strategies are the carry trade (which shorts low-interest rate currencies and goes long high interest rate currencies) and the momentum strategy (which shorts currencies which have recently depreciated and goes long currencies which have appreciated).
Our first finding is that John Maynard Keynes’s currency trading strategy was based on a sophisticated analysis of macroeconomic fundamentals such as expected changes in official interest rates, the inflation outlook, and the level of European reparations and international capital flows. His currency positions were consistent with the currency views he expressed in newspaper articles and other publications at the time. His strategy therefore eschewed trading rules such as carry and momentum in favour of a discretionary approach where he relied on exercising his own judgment.
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