Dear MoneyNews Reader,

Over the last 10 days, currency ranges have broken wide open as the dollar slumped against most major currencies. This is in stark contrast to the past year when currencies traded in a tight range against the dollar.

Until recently, traders had found it hard to make money in currency trading this year.

On Nov. 20, Bloomberg News ran an article depicting the plight of currency traders. According to data from Daniel B. Stark and Co. of San Diego, the $70 billion under management by commodity trading advisers (CTAs) had returned a miniscule 1.4% thanks to some of the largest losses from currency trading since 1994.

Bloomberg quoted Jeremy O’Friel, principal at Appleton Capital Management in New York, who said, "it’s been brutal. In the absence of volatility, it’s very difficult to make money." His currency fund had lost 11.7% year-to-date.

Many legendary traders have amassed fortunes in the currency market. Take billionaire owner of the Boston Redsox, John W. Henry who runs a large CTA from Boca Raton, Fla. The $1.25 billion Strategic Allocation Program devotes one-third of its assets to currency trading. In 2005 the fund lost 19.2%, while this year, the fund is down 12%.

The company’s $195 million Dollar Program has fallen 34% this year according to that Stark Data.

Take Berkshire Hathaway’s Warren Buffet whose legendary bet against the dollar over the last four years is still in place. Between 2002-04 that bet yielded $2.96 billion. However, in 2005 Buffet paid back $955 million as the dollar rebounded.

[Editor’s Note: Why Warren Buffett is betting billions on a falling dollar.]

While it had been a gravy train for currency traders during the last several years, a string of Federal Reserve interest rate hikes has protected the dollar from a further fall.

Now the economy looks like it might be slowing harder than the Fed thinks, which means that the dollar might be set to leave that safe harbor in the New Year.

Up until this month, the euro traded between $1.1835 and $1.3003. In fact, in the year to October, the euro currency had stayed in its narrowest range since the unit was born in 1999. The dollar traded in just a five-cent range from $1.25 to $1.30 between April and October.

This week, however, the euro surged a high of $1.3324 against the dollar.

Across the board the dollar fell with its index against a basket of currencies sliding by 3% since mid November.

The dollar’s 4.3% swoon against the pound to $1.9787 from $1.8974 11 days ago marks its lowest level since September 1992, which was just ahead of a huge bet by one of the original hedge funds, Quantum Fund.

Back then Hungarian migrant George Soros allegedly made a billion dollars selling short the British pound sterling.

You are more than likely familiar with the name of George Soros. He’s the founder of one of the world’s most notorious hedge funds — the Quantum Fund.

Soros is renowned for his macro-views on the economy, currencies and commodity markets. He operates in the playground of the rich and doesn’t mind swinging for the fences when his analysis tells him that he’s onto something big.

Back in 1990, when I was cutting my teeth as a young buck in London’s money markets, Soros was formulating on how to take on one of the world’s oldest central banks.

It was that year that Prime Minister Margaret Thatcher announced the immediate entry of the UK in to the Exchange Rate Mechanism (ERM). Several weeks later she resigned under party pressure.

So convinced was he that the Bank of England would be unable to maintain the value of the British pound that he spent much of the next two years building a position speculating that his view would outwit that of both the British government and the mandarins at the Bank of England.

As legend has it Soros’ Quantum Fund built up a position of such magnitude selling short the British pound in favor of the German mark, that by the time the battle was over, he’d grossed a profit of a billion pounds as he bought back his short position in the British currency.

Most of the money went back to his native Hungary to help poor orphans, as the billionaire philanthropist hasn’t been short of a penny for many a year.

[Editor’s Note: Get George Soros' top stock picks for 2007.]

You often hear about these big-swinging hedge fund managers — with their legendary positions of such granduer that the mere whisper of them entering a market is enough to move it!

However, for every legendary hedge fund manager, there must be several dozen successful traders in the major financial centers whose success goes unnoticed except by their desk manager. In my own trading days in London, my annual targets were pretty lofty — set at around $2.5 million. I have the grey hairs to prove my success.

I want to tell you a short story about someone who became a personal friend of mine, not before he got black balled by the London banking community. He was labeled a "rogue" by other city traders, many of whom refused to deal with him or the privileged bank at which he used to work.

I’m not going to reveal his identity as he’s since retired from the banking world altogether. Let’s just call him John.

They had him in the dock and judged him guilty of insider trading because he’d acted on a rumor on that Friday afternoon in October 1990. Many peers alleged that this trader had plundered their trading books and cleaned up in the space of the last 15 minutes of trading on that day, leaving them high and dry when the Treasury announced the swift change in British policy.

I remember the first time we met at a chic bar, where John was holding court with several of his brokers and colleagues. He knew how to tell a tall story.

Absolutely down to earth, a native south Londoner from humble origins, and a fierce rugby player, John was a real practical joker.

I found out that John and I lived pretty close and we took the same 6:30 morning train into the city each day.

Before long we’d share each other’s newspapers on the way into work and share our insight into the money and currency markets as we crossed London Bridge across the freezing waters of the River Thames. In the winter months it would still be dark as we arrived at our offices.

John steadfastly refused to comment about the ERM debacle that had alienated him from so many city traders. In his eyes he’d done nothing wrong. The millions of pounds he’d earned for his bank were done so quite legitimately and within the framework of the rules at the Bank of England.

It wasn’t until several years later and shortly before I hopped on a p*** to settle in the United States that John finally spilled the beans as to what happened that day. It was no small controversy either. While the news was the buzz in the city of London, within three months it was making national news. Here’s what The Independent newspaper said shortly after the affair blew up:

“This week, there have been persistent stories in the money markets that some firms have been angered by losses they made on deals done in Floating Rate Agreements just before the official announcement.”

The Independent October 21, 1990

And those deals weren’t small potatoes either. According to a member of parliament as reported in the Financial Times on Jan. 16, 1991, “He said the allegations suggested that Gerrard & National bought pounds 35 million of forward foreign exchange contracts — compared with their normal daily trading of pounds 2 million to pounds 5 million — invested a further pounds 100 million in the UK government bond market.”

You see, the timing of the announcement came as trading had all but finished for the day in the pretty liquid market for interest rate futures. So many traders entered into positions in a traditional afternoon frenzy only to find themselves stuck with positions they couldn’t unwind once the decision had been made. The Treasury announced the level at which the pound would enter the system as well as an unexpected interest rate cut.

But where the bank really made its money hand over fist was in John’s specialist area. He was the forward rate trader. These complex derivatives locked traders into interest rate commitments with other banks in vast notional amounts. According to The Independent, “[Gerrard] increased its exposure to sterling forward rate agreements by a further pounds 1 billion.”

With that kind of position size in a one-year forward rate contract Gerrard could have stood to benefit from a pound 10 million profit over the weekend, at the expense of traders around the city. So you can see why other traders might have been a little hot under the collar.

Complaints were lodged against Gerrard and National Discount House to the Bank of England. A parliamentary motion was tabled to investigate whether a specialist bank had dealt on inside knowledge and profited handsomely by doing so. More over highbrow banking officials had wanted to know why they had been exploited.

I can tell you that back at that time, we all knew that Britain would join the ERM. No one knew quite when. In 1990, few people felt that the economic environment was right for Britain to join. The biggest worry was whether the pound could hold its own against the mighty German mark. If the entry rate at which the pound was set too high it could put interest rates under pressure and cause the economy to fail.

In other words it was felt that the time wasn’t right for the UK to join forces with Europe. So few traders were betting on it at that time.

However, Gerrard felt that the decision would come over a weekend and that as such it would be a surprise when it was announced. So with alarming regularity each Friday they’d take some sizeable positions in the market in the hope that one weekend they’d hit the jackpot.

However, I can tell you that not every weekend did they roll out the big guns as they did on Oct. 5, 1990.

Let me give you some background on the role of a discount house in London’s money markets.

These specialist institutions used to be the buffer between the Bank of England and the big four clearing banks. Those major banks would then deal with the rest of the banking system. While the discount houses were pretty small, they had incredible weight in the market and would often have some insight into what the Bank of England was up to on a day-to-day basis.

Because their role was to act between the top tier of major banks and the Bank of England, there was an historically intimate role between senior traders at the discount houses and their counterparts.

For some reason, the messengers at these houses would walk from bank to bank borrowing and lending major sums of money as written on a banker’s draft of acceptance. To maintain their importance these characters would be distinguishedly dressed.

A messenger would typically wear a tall, black top hat and tails of a soft salmon color. These men would look more at ease in a Dickens story, but blended right into life in the city of London just 10 short years ago. People were so accustomed to see them bustling between banks that they rarely batted an eyelash.

These messengers would wander from the discount house to other banks and finally the Bank of England where they would borrow, deposit and tender bids for money at the bank’s prevailing rate.

Here’s what really happened that day in October. As usual Gerrard was wondering what might happen that coming weekend. Nothing untoward was occurring. The messengers were out and about as usual on Friday, when one out of breath chap rolled back into the office having rushed back from the foyer at the Bank of England on Threadneedle Street.

He gushed out his words to the directors in the office. The Bank’s own messengers and staff were running around the foyer at the Bank like headless chickens!

Never before had he witnessed such a hive of activity as mandarins rushed around the hallowed halls following orders and falling over one another.

The messenger had already twigged what was going on and so to had the directors. Clearly the melee going on at the central bank was on account of an unexpected change that only those who needed to know were aware of.

The directors instructed the dealing staff to implement the plan of action. Immediately each of them took to their phones, Reuters communications devices and plunged headlong into the market before anyone else got wind of the news. Of course any of the other discount house messengers might have noted the same commotion at the Bank of England.

If someone else acted on that information the gig would be up.

John’s forward rate book was the piece de resistance in all of this. It was a pretty liquid market at the time and to enter a few simple trades of the maximum one-year duration was the most efficient way to enter the market at the time.

It took a few calls to one or two trusted brokers, one or two Reuters calls to other major counterparts — to other leading players — and the deed was done.

One BILLION pounds worth of deals in under 15 minutes. From what I recall of that afternoon, the market suddenly got locked into a frenzied upswing as traders began to fear that the rumor was much more than a rumor.

When news of the size of the trades was confirmed by futures brokers, bond and money brokers, big-time bankers began to jump on the back of the move in the belief that only a fool would make a bet of such proportion with only a grain of knowledge about what was going on.

It was only minutes later when the markets were locked on the way up that confirmation came in an emergency press conference by the British Treasury to tell the city of London their strategy for the pound, interest rates, and the economy during the course of the weekend.

Was it insider knowledge? I’m not sure it was.

Certainly Gerrard and National was in a privileged position to witness the mêlée at the Bank that afternoon. But they were prepared each weekend to act that way in order to capitalize on a sure-fire winner.

John had followed his orders and executed the directors’ wishes. It left him a richer man if not in monetary terms, certainly in spirit following the excommunication he encountered.

John left the city several years later disillusioned with life as trader.

Back then the freefall subsided because the government decided to quit the ERM, and the pound was allowed to find its own level. Perhaps now the bell tolls for the American dollar loud and clear for all to hear.

In 2005 the bells were muffled as the dollar faced a well-earned pause in its decline, yet the signs were still there.

The trade deficit continued to swell as American consumers binged on manufactured goods from around the world. The government spent far too much and collected too little sending the budget deficit from a healthy Clinton-era surplus to a gargantuan deficit.

But the dollar found its feet as the Federal Reserve built a delightful scaffold below it, underpinning it through steady interest rate rises making it an attractive buy for speculators. So much so that central banks and oil-rich nations poured their riches and reserves into the greenback especially when it seemed to have steadied.

Yet now that the string of rate rises has ended those same dollar buyers are looking for the next best thing. They're finding solace in an expanding euro currency where the ECB is set to inch further towards dollar-land interest rates next week with perhaps more next year.

In Britain, rising housing prices could force the Bank of England to lift rates once more. All of which tells us that these same investors are telling us that the dollar is still too expensive. Such a scenario has them concerned that the scaffold is no more than a house of cards.

China’s central bank is hinting that it will rebalance currency reserves in favor of more yen and euros — as are many Middle Eastern banks. Where will the dollar's fall stop?

In the case of the pound back in 1992, when it was rudely ejected from the exchange rate mechanism, the crowd stopped selling it short when they began to see the green shoots of recovery begin to show through the soil.

The British economy became a more fertile ground with a cheaper pound. And right now that's what investors are telling us about the economy over this side of the Atlantic. For the United Kingdom that equilibrium took a matter of months to occur.

That same degree of equilibrium is still being determined as the dollar continues its decline after what turns out to be only a temporary reprieve. The four-year freefall has resumed once again so it seems.

How much longer will it last? Another four years perhaps?

Have a great weekend!