loans and money

As with the supposed efficiency of markets, which does not actually work in practice, so there is the idea that supply and demand are completely independent of one another. If this were so, price trends could not exist because markets would instantly work to eliminate any supply or demand imbalances. The fact that this does not happen and that price trends do occur suggests that there are lags, sometimes substantial lags, before such imbalances can be eliminated. In addition, supply and demand are not completely objective concepts. Rather, at least in part, they reflect the views expressed by those market participants that make up that supply and demand. In other words, supply and demand are both cause and effect.
So much for the theory, what does this mean in practice? Actually, to a market practitioner, these ideas are relatively obvious. Currency interbank dealers know full well that particular flows will have more effect than others and thus will materially affect the supply/demand dynamics. Say a large multinational corporation transacts an end-of-quarter hedge in the Euro–dollar exchange rate. Granted, this is the most liquid currency pair in the world, but if the flow is large enough it may affect both current market pricing and future market thinking. Of course the term “future” means different things to different people. To the multinational, it means months at least if not years. To the interbank dealer transacting the flow in the market place it means minutes or hours at most. Currency markets are essentially flow-driven over short time frames, and therefore it is vital to understand the relationship between supply and demand dynamics.
Just as supply and demand are not independent of one another and are both cause and effect, so the relationship between “speculation” and economic fundamentals is also not just one-way. Economic theory requires that markets eliminate “speculative excess”, thus restoring equilibrium. However, we have already established that “equilibrium” is actually a moving target. If the “speculative excess” is the extent to which markets diverge from equilibrium, then that “speculative excess” is also a moving target. Finally, the presumption of economists is that economic fundamentals drive market pricing and thus to an extent speculative excess. Even if we accept this, it has also to be acknowledged that speculative excess can in turn affect economic fundamentals. This is best proven by example.