The Returns to Currency Trading: Evidence from the Interwar Period

Olivier Accominotti and David Chambers*

March 2013

VERY PRELIMINARY. PLEASE DO NOT QUOTE OR CIRCULATE.

Abstract

Modern foreign exchange trading first emerged in the interwar period. This paper studies the returns to currency speculation in the 1920s and 1930s. Our first finding is that the returns to simple carry and momentum currency trading strategies characteristic of modern markets are also present in the interwar years. Second, using archival data we analyze the trading record of a prominent currency speculator of that period: John Maynard Keynes. We find that, unlike most currency speculators nowadays who rely on trading rules, Keynes was a discretionary trader who founded his decisions on a sophisticated analysis of macroeconomic and   political   factors.   However,   Keynes’   fundamental-based strategy failed to match the returns to carry and momentum in the interwar years. These naïve strategies yielded particularly high returns in the 1920s and, as in the modern period, performed better than equities and bonds.

* Olivier Accominotti is Lecturer at the London School of Economics and Political Science, Economic History Department, Houghton Street, London, WC2A 2AE, United Kingdom and CEPR Research Affiliate. Email: o.accominotti@lse.ac.uk. David Chambers is University Lecturer in Finance at the Judge Business School, University of Cambridge, Trumpington Street, Cambridge, CB2 1AG, United Kingdom. Email: d.chambers@jbs.cam.ac.uk. We thank Norman Cumming, Mike Humphries, Antti Ilmanen, Momtchil Pojarliev, Alan Taylor, and participants at the London FRESH Meeting for advice and comments. All errors are ours.

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1. Introduction

How large are the returns to currency speculation? Until recently, conventional thinking

among economists was that currency trading was a zero-sum game. The Meese-~Rogoff

result stated that the best currency forecasting model was a random walk with no drift and

hence short-run changes in exchange rates were unpredictable (Meese and Rogoff, 1983a,

1983b). The risk neutral efficient market hypothesis (EMH) held that the forward exchange

rate was on average a good predictor of the future spot rate and the uncovered interest parity

condition (UIP) that high interest rate currencies depreciated against low interest rate

currencies by the interest rate differential. Hence, standard finance theory implied that the

expected return to currency speculation was zero. Yet, such a prediction is clearly rejected in

the data. Early empirical studies have shown that UIP is violated at short or medium-term

horizons (Hodrick, 1987; Froot and Thaler, 1990). Recent research has demonstrated that the

carry trade strategy, which borrows low-interest rate currencies to invest in high interest rate

currencies, has exhibited generally high returns since the 1970s (Lustig and Verdelhan, 2007,

Brunnermeier et al., 2009, Burnside et al. 2011, Jorda and Taylor, 2012, Menkhoff et al.,

2012a). Carry strategies exhibited large losses during the 2008 financial crisis, supporting the

hypothesis that their profitability in normal times is compensation for tail risks (Fahri and

Gabaix, 2008, Fahri et al., 2009). Moreover, a second naïve currency trading strategy,

momentum, which shorts currencies with low past returns in favour of going long currencies

with high past returns, has also proven to be very profitable (Okunev and White, 2003,

Gyntelberg and Schrimpf, 2011, Menkhoff et al., 2012b) and continued to perform well

during the recent financial crisis (Burnside et al. 2011).

Exactly why such simple zero-cost investment strategies can be so profitable is the

subject of debate. Some authors have argued that the profitability of carry and momentum

strategies can at least be partly explained by limits to arbitrage, whether due to myopic

traders, high transaction costs and the existence of price pressure (Lyons, 2001, Burnside et

al., 2011, Menkhoff et al. 2012b). A second view claims that the returns to carry and

momentum strategies are compensation to investors for risk-taking (Lustig and Verdelhan,

2007, Menkhoff et al., 2012b, Fahri and Gabaix, 2008, and Fahri et al., 2009). As such, these

returns represent beta or factor returns in currency trading. When factor models are used to

benchmark currency trading performance, much of the excess returns of modern currency

managers are absorbed by these factors and the average manager fails to generate positive

alpha after fees (Pojarliev and Levich, 2008, 2012).

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Foreign exchange trading as we know it today first emerged in the 1920s and 1930s.

Most economists and historians associate the interwar period with financial turmoil and

repeated speculative currency attacks, but this period also marks a major transformation in the

foreign exchange market. Until World War 1, currency markets were characterized by dealing

in bills of exchange, which acted both as instruments of credit and of foreign currency

exchange. Beginning in 1919 however, dealings by telegraphic transfer replaced transactions

in bills giving birth to the modern spot exchange markets with which we are familiar today.

Furthermore, the forward exchange market developed apace in the early 1920s (Einzig, 1937).

An active forward exchange market emerged for the first time in London, which quickly

established itself as the world’s   dominant currency center. The Financial Times began

publishing quotations of forward exchange rates on a daily basis. Historians of foreign

exchange markets have documented the increasing intensity of currency trading activity

among both professional and retail foreign exchange traders in the interwar years (Einzig,

1937; Atkin, 2005). However, there have been no empirical studies of the returns to currency

trading in this period to match the considerable literature on post-Bretton Woods currency

trading.

In this paper, we provide the first study of returns to currency trading at the very onset

of modern foreign exchange markets. We begin by analyzing the trading record of one

prominent currency economist and trader of the interwar period: John Maynard Keynes.

Keynes was the first economist to publish an explicit formulation of the covered interest

parity (CIP) condition and among the first to examine the purchasing power parity (PPP)

condition empirically (Keynes, 1923). Between August 1919 and May 1927, and again

between October 1932 and March 1939, Keynes traded currencies via the forward market,

betting on the future evolution of spot exchange rates. It is extremely rare to obtain detailed

transaction data for any professional currency trader let alone a trader such as Keynes. We

supplement our analysis of his currency transactions with that of his archival correspondence

revealing the motivations behind his currency trading decisions.

Our first main finding is the returns from pursuing the same carry and momentum

trading strategies which have gained popularity today are also present in the interwar period.

We follow the approach of the recent literature and explore the returns to these strategies in

the cross-section of currencies (Lustig and Verdelhan, 2007; Menkhoff et al., 2012a, 2012b).

Across the interwar period, our results demonstrate that the returns, both raw and risk-

adjusted, to the carry and momentum strategies were high both relative to stocks and bonds

and to the same currency strategies in the 1990s and 2000s. When we decompose the interwar

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returns into two sub-periods, we find that both carry and momentum currency strategies

performed better than the UK stocks and UK bonds over 1920-1927. However, the returns to

the momentum strategy were much lower over 1932-1939 and the carry trade recorded

negative returns.

Our second main finding is that Keynes was a discretionary trader who relied on a

sophisticated analysis of macroeconomic fundamentals and political factors to form his

currency trading views. As such, the correspondence on his currency trading showed no

evidence of his systematic pursuit of the naïve carry and momentum strategies characteristic

of modern currency trading. In  keeping  with  the  performance  evaluation  of  today’s  currency  

managers, we benchmark  Keynes’  performance  against the returns to carry and momentum.

Surprisingly, we find that despite being a well-informed trader, Keynes failed to match the

returns on these naïve strategies with the important caveat that our estimates of the carry and

momentum factor returns ignore any transaction costs, costs which at certain times during the

turmoil of the interwar years may have become considerable. Keynes’   performance   as   a  

currency trader stands in contrast to his prowess as a stock picker (Chambers and Dimson,

2012).

The remainder of the paper is organized as follows. Section 2 describes the emergence

of modern foreign exchange markets in the interwar period. Section 3 discusses our data and

sources. Section 4 documents Keynes’   currency trading strategy and analyzes his trading

style. Section 5 examines the performance of carry and momentum strategies on interwar

markets. Section 6 then benchmarks Keynes’   own  performance   against the returns to these

strategies or factors. Section 7 concludes.

2. Foreign exchange markets in the interwar period

2.1. The emergence of forward markets

Forward currency markets first emerged in Vienna and then Berlin in the second half of

the 19th century (Einzig, 1937: p.37-38, Flandreau and Komlos, 2006). There was no forward

market to speak of in London at this time largely due to the fact that British exporters were

able to invoice in sterling and generated little or no demand for foreign exchange cover

(Einzig, 1937: p.48). However, a market did develop rapidly in London as soon as the war

ended largely for three reasons (Atkin, 2005: 48-51). First, the rise of the US dollar to rival

sterling as the leading currency in the 1920s led to a surge in trading of the USD/sterling

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exchange. Second, forward exchange contracts replaced the use of bills of exchange as traders

realized the disadvantage of using long-dated foreign bills which required settlement at the

initiation of a contract compared to forward contracts where settlement is delayed until

maturity. Third, the sterling exchange rate floated freely until returning to the gold standard in

1925. Currency business in London was conducted by telephone and with banks and an

assortment of foreign exchange brokers either executing customer orders undertaken for

hedging trade or investment transactions, for arbitrage or for speculation (Einzig: p.85-94).

Paris for continental European currencies and New York for sterling/dollar were the next most

important markets after London in the interwar years. Whereas in the early 1920s currency

speculation was largely the preserve of professional investors, considerable retail investor

interest was to emerge thereafter (Einzig, 1937: p.145).

Foreign exchange trading disappeared as the major currencies returned to the gold

standard in the second half of the 1920s. Although trading recovered following the end of UK

Treasury foreign exchange restrictions in March 1932, activity remained subdued compared

to the 1920s for several reasons. A continued slump in world trade depressed business

demand for foreign exchange. In addition, both the emergence of a Sterling Bloc comprising

Dominion and Scandinavian countries among others pegging their currencies to sterling and

the adoption of exchange controls by Germany and Italy considerably reduced the number of

trading options down to the currencies of Britain, the United States, Canada, France,

Netherlands, Belgium and Switzerland (Atkin, 2005: 69-72). Even then attempts were made

by the authorities in London and Paris to enforce embargos on forward exchange transactions

undertaken for purely speculative purposes from July 1935 onwards (Einzig, 1937: p.79).

How large was currency trading activity in the interwar period? Both Einzig (1937) and

Atkin (2005) suggest it was significant. Unfortunately, no systematic attempt was made at that

time to collect information on foreign exchange turnover in a similar way as the Bank for

International Settlements (BIS) does today in its triennial survey. Nevertheless, an internal

Bank of England document dated January 1928 estimated daily foreign exchange turnover on

the London market between £4.9 and £5.5 million, representing roughly 30% of British GDP

and 20% of the volume of world trade on an annual basis.1 USD/£ transactions dominated the

London foreign exchange market and represented between 73% and 82% of all currency

transactions according to the estimate. The other major currencies, French franc, German

1 The estimate of foreign exchange turnover is from Archives, Bank of England, EID3/281, “Approximate  amount   of   foreign   currency   changing   hands   on   the   London   market”.   The   GDP   estimate   and   estimate   of   the  volume of world trade for 1928 are respectively from Mitchell (2007) and Maddison (1995). We assume 250 trading days per year.

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mark, Italian lire, Dutch florin, Belgian franc, Swiss franc, accounted for between 7% and

11% of currency turnover.

2.2. Interwar currency instability

These profound transformations of the foreign exchange market took place in a context of

dramatic currency instability. We can divide the interwar years into three periods: the floating

exchange rate era, January 1920 to December 1927; the gold standard period, January 1928 to

August 1931; and the managed floating era, September 1931 to August 1939.2

The floating exchange rate era from January 1920 to December 1927 represent those years

when all major currencies embarked on a long road back to the gold standard. During WW1,

fluctuations   in   the   belligerent   countries’   currencies   had been dampened through a

combination of exchange restrictions and official foreign exchange market interventions. In

1919 however, capital controls were removed and the US stopped intervening on currency

markets. As a consequence, European currencies depreciated sharply. Sterling fell a long way

below the pre-war USD/£ parity of 4.86 and down to a level of 3.50 while the French franc

and German mark depreciated even more. Yet, expectations that European countries would

soon return to the gold standard at their pre-war parity remained prevalent at that time

(Keynes, 1924, Einzig, 1937, Mixon, 2011). Continental currencies traded at a premium

against sterling on the forward market in 1919-1920, whereas the US dollar exhibited a

forward discount, which led Keynes to write that “the  market  was  a  bull  of  sterling”.3

However, any thoughts of a swift return to gold were soon banished by the sharp

recessionary experience of 1920-21. Although the Genoa Conference of 1922 issued

recommendations on how to reconstruct the international monetary system, it was not until

the mid-1920s that the gold standard system was fully re-established. The British government

played a long game in pursuing its objective of returning to pre-war parity. Despite strong

opposition by Keynes on the basis that sterling was overvalued by 10-15% (Keynes, 1925),

Britain finally re-established the link to gold in April 1925.

The road towards gold convertibility was even more turbulent for France and Germany,

whose economic policies were dictated by the negotiations over German reparations. The

failure to settle the reparations issue led to economic stagnation, as Keynes (1919) had

warned, and   both   countries’   efforts   to   stabilize   their currency were undermined by budget

2 This section draws heavily on Eichengreen (1992) and (1998) ch.3. 3 Quoted in Einzig (1937, p. 263).

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deficits and high inflation. Germany slid into hyperinflation and lost its currency. The

depreciation of the French franc reached crisis proportions when fears of a capital levy forced

French investors to flee the country and reduced the currency to a level of FFR200/£1 in July

1926. At this point, Poincare’s return to power removed the threat of a capital levy and the

budget was balanced. Although France did not officially reintroduce gold convertibility until

June 1928, the franc was de facto stabilized (at a new gold parity) by the end of 1926.

The transition in December 1927 to the gold standard period which followed was

complete when the Italian lire, the last of the eight major currencies in our sample, returned to

gold. However, currency stability only lasted a short while. The first signs of the strictures

imposed by the gold standard appeared among the commodity-exporting developing world.

Facing ongoing commodity price deflation, they had no choice but to devalue as early as

1929. Shortly afterwards, the industrialized world then began to run into trouble following the

sharp stock market declines in the autumn of that year. Nonetheless, the major currencies

clung on to gold until banking and balance of payments crises forced first Austria and then

Germany in July 1931 to suspend convertibility and to adopt exchange controls.

The final managed floating period then began with the Sterling Crisis of September 1931.

The financial crisis in Central Europe rolled on to London and the speculative pressure on

sterling became immense (Accominotti, 2012). Sterling departed the gold standard on

September 21st and the US dollar became the next target for currency speculators. The Federal

Reserve defended its gold parity for the next 18 months but as in the case of Britain the

deflationary consequences for the domestic economy of staying on gold became intolerable

and the new Roosevelt administration took the dollar off gold in April 1933.

Both in the case of the departure of Britain and the US, a succession of countries

followed. In Europe, a hard core of gold bloc countries hung on to gold parity until they too

departed one by one – Belgium in March 1935 and France, the Netherlands and Switzerland

in September 1936. Although all the major currencies came off gold, this did not herald a

return to the floating exchange rate period of the 1920s. Rather, this was a managed floating

exchange rate regime characterized by frequent central bank intervention and the imposition

of capital controls. In such a regime, currency volatility was dampened and in the case of

some currencies transactions became either too expensive or infeasible.

The economic literature has focused on two main aspects of interwar foreign exchange

markets to date. First, authors have tested important exchange rates theories on the floating

exchange rate era of the 1920s. Taylor and MacMahon (1988) examined the validity of the

purchasing power parity theory. Peel and Taylor (2002) have explored the covered interest

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parity condition on the sterling/dollar market. MacDonald and Taylor (1991), Philips,

McFarland and McMahon (1996), and Diamandis et al. (2008) have tested the forward

exchange market efficiency hypothesis. Second, economic historians have studied in detail the

contribution of exchange rate regimes and exchange rates policies to the Great Depression

(Eichengreen, 1992, Temin, 1989, Bernanke, 2000, James, 2001). However, we believe that to

the best of our knowledge we are the first to examine the economics of currency trading

during the interwar period.

3. Data and sources

Keynes began trading currencies on his own account in September 1919 as soon as he

returned from the Versailles Conference. He was continuously active across two periods from

August 1919 to April 1927 and from October 1932 to February 1939. The intervening period

was marked by currencies returning to the gold standard. He recorded all his spot and forward

purchases  in  his  personal  investment  ledgers  which  are  kept  in  the  archives  at  King’s  College,  

Cambridge. In total, 714 transactions are recorded, 355 forward market contracts and 359 spot

trades. In addition, there are 18 continuation trades in the database. For each spot transaction,

we record the date of the transaction, the nominal value of the contract, and the exchange rate

versus sterling at which he contracted. For each forward transaction, we again record the date,

the nominal value, the exchange rate at which he contracted to buy or sell foreign currency

against sterling and the date on which delivery was to take place. From the latter we calculate

the duration of each of his forwards. Typically, Keynes took out a forward contract to buy or

sell a currency and then chose one of three options: (i) to close the position with a spot

purchase in the days immediately before the delivery date; (ii) to close the position well

before the delivery date; and (iii) to continue the forward position by renewing it.

Table 1 summarizes the annual time series of all his currency trades for his personal

account. In the 1920s, he mainly traded US dollars (USD), German marks (MKS), French

francs (FFR), and Italian lire (LIRE) versus the sterling pound. Consistent with the description

of interwar currency markets in the previous section, Keynes’s  investment opportunity set had

shrunk in the 1930s due to the introduction of exchange and capital controls. He only traded 3

currencies, USD, FFR and the Dutch florin (DFL) and his trading was dominated by his USD

position. For each year, we report the number of trades in each currency, the average sterling

value and the average duration in number of days of the nominal forward position.

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Alongside trading on his own account, Keynes speculated in currencies beginning in

January 1920 on behalf of a syndicate managed together with O.T. Falk comprising their own

capital and that of friends and family (CWKXII: p.5-6). As is well-known, this syndicate soon

ran up considerable losses and was closed out in May 1920. The trading positions undertaken

for the syndicate are similar to those undertaken for his own account. He also traded

currencies for his Cambridge College where he was bursar. In this case, he only traded during

the 1930s and his trading was even more dominated by the US dollar/sterling contract which

accounted for 80% of his positions.

We supplement the detailed transaction-level   data   with   a   careful   analysis   of   Keynes’  

currency   views   drawn   from   his   correspondence   located   in   the   archives   of   King’s   College  

Cambridge and  at  the  British  Library’s  manuscripts  section.

Finally, we assemble a monthly dataset of spot and forward exchange rates (against

sterling) for the major currencies traded in London during the interwar years. The data on spot

exchange rates cover the 1918-1939 period whereas forward exchange rates are available as

of 1920 only. These data are taken from published sources including Diesen (1922) for

1918/1919, Keynes (1923) for 1920/1921, Einzig (1937, pp. 450-481) for 1922-1936 and The

Economist for 1937-1939. Exchange rates correspond to end-of-month quotations (last

Saturday of each month)4 rather than monthly averages.

4. Keynes’  currency trading

4.1. Descriptive evidence

In this section we describe Keynes’   currency   trading   activity   in   the   1920s   and   1930s.  

Figure 1 displays his cumulative gross position in all currencies (long and short) expressed in

pounds sterling from August 1919 to March 1939. Keynes’  gross  position  fluctuated  between  

zero and £100,000 over 1920-1925, peaking in August 1923. In May 1920, January-March

1922, November 1923-March 1924, and December 1924 -January 1925, Keynes closed all his

forward positions. Thereafter, he traded only occasionally until May 1927, at which point he

stopped trading completely.

Keynes returned to currency trading in October 1932, one year after the UK had left the

gold standard. During the following period, the value of his cumulative gross position 4 Except for 12/1919-10/1920 (first day of the following month) and 11/1920-12/1921 (first Wednesday of the following month).

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progressively increased until it reached £250,000 in December 1936. This higher level of

activity in the 1930s compared with the 1920s reflects Keynes increased personal wealth

which averaged over £150,000 in the 1930s compared to slightly more than £40,000 in the

mind-1920s (CWK XII, p.11, Table 3). From December 1936 onwards, he progressively

reduced the volume of his position and he definitively stopped trading in March 1939.

Figure 2 and Figure 3 provide the  breakdown  of  Keynes’  monthly  position  across the

different currencies in 1919-1927 and 1932-1939 respectively, distinguishing between long

(+) and short (-) positions. Figure 4 graphs the evolution of his position in each individual

currency against the spot exchange rate against sterling.

Keynes constantly shorted the French franc, German mark and Italian lire from 1919 to

1925 with few exceptions (Figure 2). Interestingly, he interrupted his trading in the French

franc during the speculative attack of November 1923-March 1924. He also took small long

positions in the French franc and Italian lire in July 1926 at the very height of another

speculative attack against these two currencies, presumably believing that they had over-

depreciated. In comparison, Keynes’  trading  of   the US dollar was less consistent during the

1920s. Although he generally went long the US dollar in this period, he did adopt a short

dollar position on several occasions, in January-February 1921, November-December 1922

and October 1924.

When Keynes resumed currency trading at the end of 1932, he initially alternated

between short and long positions in the US dollar, French franc and Dutch florin (Figure 3).

He shorted the dollar in October 1932-February 1933 but closed his position on 2 March

1933, just before the US devaluation. In the following months (April to June 1933), he even

went long the dollar believing that its depreciation following the departure from the gold

standard had been overdone. However, from July 1933 until March 1939, he constantly bet

against the dollar with his short position reaching a maximum in December 1936.

Keynes’  trading  in  the  French  franc  and  Dutch  florin  also  reveals  his lack of confidence

in the ability of France and Holland to endure the Great Depression and remain on the gold

standard. He first shorted the franc and florin from March 1933 to December 1933, expecting

France and the Netherlands to follow the US off gold. He then once again speculated against

the French and Dutch currencies from July 1934 until September 1936. When the two gold

bloc currencies were eventually devalued in September 1936, Keynes immediately closed out

his franc and florin positions and did not trade them again in the years that followed.

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4.2. Keynes’  trading  profile

Overall, the descriptive evidence does not seem to suggest that Keynes relied on specific

rules to determine his currency investment decisions. In the following, we review the

qualitative evidence from his correspondence in order to identify the motivations behind his

currency  decisions.  The  correspondence  confirms  that  Keynes’  approach  to  currency  trading  

was not rule-based. On the contrary, we find that he was a discretionary trader who relied on

his personal analysis of macroeconomic fundamentals, which he interpreted in a non-

systematic way.

In   1919   and   1920,   much   of   Keynes’   correspondence   on   currencies   was   with   his   then  

investment confidant, syndicate partner and stockbroker O.T. Falk (PP/JMK/SE/2). The focus

of this dialogue was almost always on macro-economic fundamentals such as expected

changes in official interest rates, European reparations and international capital flows and the

inflation outlook. Keynes along with Falk was part of the British negotiating team at the

Versailles Peace Conference and was as a result well-connected in the world of international

finance in the 1920s. One exchange of letters with Falk refers to his lunching with the US

diplomats and bankers involved in the discussions as to whether to extend US credit to Europe

in 1919 (PP/JMK/SE/2/1/13-14). Did his connections make him an insider? We cannot be

sure. However, in general, we do not find among his correspondence any clear evidence that

he had privileged access to private information.

A  very  good  example  of  Keynes’  fundamentals-based approach is the most detailed of his

memoranda on currencies, a note on the sterling exchange rate written for the board of a

leading closed end fund on February 1932 (PP/BM/6/6-18). His analysis is split into two

parts. First, he begins by analyzing and quantifying his expectations as to future changes in

the UK Balance of Payments, including the trade account, the invisibles account and capital

transactions. Second, he tries to dissect the interventionist policies of the main central banks,

in this instance the Bank of England and the Bank of France. His focus is always on those

areas  where  his  forecasts  differ  from  the  consensus.  In  this  particular  instance,  he  “considers  it  

a  great  mistake  to  be  too  bearish  of  sterling”  because  he  is  more  optimistic about the prospects

for  improvement  in  the  trade  balance  following  sterling’s  devaluation  and  the  introduction  of  

tariffs, the continued likelihood of the Sterling Area prospering and accumulating foreign

balances in London to the benefit of sterling and the willingness of the Bank of England to

intervene in support of sterling.

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The other notable passage in this note is his conclusion that more countries would come

off the gold standard as early as 1932, particularly, South Africa, Holland and Belgium, but

not Switzerland, France or the US. His directional forecast was correct in all cases but his

timing was off by several years in the case of Holland and Belgium. Indeed, in December

1934 he himself recognized the great difficulty in forecasting the timing of large currency

moves stating that:

“Nothing  is  more  rash  than  a  forecast  with  regard  to  dates  on  this  matter.  The  event  

when it comes will come suddenly. The best thing is to allow for probability and put

little  trust  in  forecasts  of  the  date,  whether  soon  or  late”  (BM/1/178)

In the 1930s, most of his correspondence dealt with his views on the US dollar consistent

with at least four out of every five of his currency trades being in the dollar. His views on the

dollar once it had come off gold proved incorrect. Based on his reasoning that it  was  “difficult  

to  see  how  a  creditor  country  can  keep   its  currency  depreciated”,  he  concluded  on  21  April  

1933  “that  the  dollar  is  probably  undervalued  and  ought  to  be  bought  at  today’s  price  of  3.90”  

(PP/BM/70-72). Later the same month, he confessed that  “I  am  still  very much in the dark and

apart   from   the   opinions   in   the   press   have   nothing   to   help   me   except   my   own   ideas”  

(PP/BM/78-79). A sentiment he repeated on several occasions and further evidence that if he

had been an insider in international finance in the early 1920s, he certainly was not one by the

1930s – at least as far as the US was concerned.

5. Carry and momentum strategies in the interwar period

The qualitative evidence reported above suggests that Keynes’   strategy   was   based   on  

fundamental analysis. Most currency traders today avoid this style of trading in preference to

rule-based trading (Pojarliev and Levich, 2010). Indeed, empirical studies since the 1980s

have shown that structural exchange rate models perform poorly at predicting future exchange

rates at short-term horizons and fail to do a better job than a simple random walk model

(Meese and Rogoff, 1983, 1988, Chinn and Meese, 1995, Cheung et al., 2005). Furthermore,

recent empirical research has revealed that naïve trading strategies have performed very well

in the post-Bretton Woods period. Among them, two classes of strategies have attracted

attention from the literature. First, the carry trade, which goes long high-interest currencies

and short low-interest currencies exploits the “forward  premium  puzzle”. Second, momentum

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strategies which go long currencies with high recent returns and short currencies with low

recent returns exploit the fact that currency movements persist over short or medium term

horizons. Whereas the empirical literature has documented extensively how carry and

momentum strategies have performed in the last thirty years, there have been no studies of the

returns to these strategies during the other period during the 20th century when exchange rates

were floating. In this section, we document their performance in the 1920s and 1930s.

We consider a set of currency speculation strategies focusing on the eight currencies for

which an active forward exchange market existed in the interwar years: the pound sterling

(GBP), the US dollar (USD), the French franc (FFR), the German mark (MKS), the Italian lire

(LIRE), the Dutch florin (FFL), the Belgian franc (BFR) and the Swiss franc (SFR). Forward

exchange rates quotations were not always available for all currencies in this period. In the

case of the German mark, no sterling/mark forward transactions occurred during the

hyperinflation period from September 1923 to October 1924 and after the introduction of

capital controls in July 1931. Table 2 summarizes the information on data availability for our

sample currencies.

We study the returns to a carry strategy (CARRY) and four different momentum

strategies (MOM1, MOM3, MOM6, MOM12) during the 1/1920-9/1939 period. In doing so,

we follow the recent literature and explore the returns to these strategies in the cross-section

of currencies (Lustig and Verdelhan, 2007, Menkhoff et al. 2012a, 2012b). At the end of each

month, we rank the eight currencies according to each of the following five rules:

(i) their forward discount (CARRY);5

(ii) their increase in value (against sterling) over the preceding 1 month (MOM1);

(iii) their increase in value (against sterling) over the preceding 3 months (MOM3);

(iv) their increase in value (against sterling) over the preceding 6 months (MOM6);

and

(v) their increase in value (against sterling) over the preceding 12 months (MOM12).6

5 If covered interest parity (CIP) holds, the forward discount is equivalent to the interest rate differential vs. the London money market rate. Peel and Taylor (2002) show that deviations from covered interest parity were arbitraged between the London and New York markets during the 1920s when an annualized profit of at least 0.5% was available. Covered interest parity between other markets is more difficult to test, as comparable short-term investment instruments were not available on all European money centers (see Einzig, 1937). 6 We also computed the monthly returns to an alternative momentum strategy sorting currencies according to their 1-month lagged return rather than lagged appreciation on the spot market. This strategy is therefore more similar to that described by Menkhoff et al. (2012a). The performance of this strategy was similar to that of our other momentum strategies during 1920-1939. The results are available from the authors upon request.

13

For each rule, we form two currency portfolios at the end of each month. The High

portfolio is formed from equal weights in the two highest ranking currencies and the Low

portfolio from equal weights in the two lowest ranking currencies. We then compute the

monthly excess returns of the 2 Long-2 Short strategy which adopts a long position in the

High portfolio and a short position in the Low portfolio at the end of each month. We also

consider an alternative version, the 1 Long-1 Short strategy, which takes a long position in the

highest ranked currency only and a short position in the lowest ranked currency only.

Table 3 summarizes the performance of the 2 Long-2 Short carry and momentum trading

strategies for the period January 1920 to August 1939. For each, we report the mean

annualized return over the period, the annualized standard deviation of returns, the annualized

Sharpe ratio, as well as the skewness and kurtosis of monthly returns. We also compare

performance with that of UK stocks, represented by the DMS UK market index, and of UK

government bonds, represented by Consols. Given the shifts in currency regimes in this

period, we further examine performance during three sub-periods corresponding to the

floating exchange rate era (January 1920 to December 1927), the gold standard period

(January 1928 to August 1931) and the post-sterling crisis era (September 1931 to August

1939).

The German mark collapsed under hyperinflation in August 1923. While forward

quotations for the German mark were available up to this month, the rapidly escalating

counterparty risk effectively made forward contracts in marks unavailable to currency

investors from early 1922 onwards other than in the smallest amounts. Keynes, himself, only

engaged in five forward transactions in marks during these twenty months and these were all

for amounts lower than £500 compared to his average trade size of £7,292 in other currencies

during these twenty months and of £3,529 in marks in the two previous years. Hence, we

exclude the German mark from the sample from January 1922 to August 1923.

The striking result from Table 2 is that the same naïve currency trading strategies which

have gained popularity over the recent years also performed well on the early foreign

exchange markets of the interwar period. Over the whole sample period 1920-1939, the carry

strategy returns on average +4.49% and the four momentum strategies yield returns ranging

from +2.63% to +5.81%. Both the carry strategy and the momentum strategies, except for

MOM6, display higher Sharpe Ratios than those available on alternative assets, UK stocks

and UK Consols. A Sharpe Ratio of 0.51 on the carry trade strategy over the 21 year sample

period compares very favorably with that on the same strategy over the last twenty years

when trading the major currencies. For example, the Deutsche Bank G10 Carry Index exhibits

14

an annualized Sharpe ratio of 0.38 over 1990-2010. Momentum strategies also performed well

in the interwar years with MOM12 exhibiting the highest Sharpe Ratio (0.61). This

performance again compares very favorably with that of the Deutsche Bank G10 Momentum

Index with a lower Sharpe ratio of 0.26 during 1990-2010.7

Figure 5 displays the cumulative performance of the CARRY strategy and two

representative momentum strategies, MOM1 and MOM12, over 1920-1939. The graph

reveals that most of the gains of these strategies were made in the floating exchange rate

period, 1920-1927. During these years, the returns to the CARRY, MOM1 and MOM12

strategies were high, +11.72%, +10.89% and +12.09% respectively, relative to the following

two sub-periods (see table 3, panel B). The returns to currency speculation then vanished

during the 1927-1931 period when all currencies in our sample had a fixed parity with gold

and exchange rate fluctuations were very muted as can be seen in the comparatively very low

standard deviation of returns on all currency strategies in Panel C.

The UK’s  departure  from  gold  in September 1931 marked the beginning of a new era of

currency volatility. However, carry and momentum strategies did not perform well during the

1930s compared to the UK stock market or consol. The carry trade recorded negative returns

(-0.95%) during 1931-1939, as did MOM1 (-0.03%). Only MOM3, MOM6, MOM12 yielded

positive returns ranging between +2.24% and +3.11%, but these were highly skewed,

reflecting the abrupt changes in exchange rates during the 1930s.

Returns to the four momentum strategies are positively correlated with each other over

the whole sample period and the three sub-periods (Table 4). However, there is no correlation

between the momentum and carry returns over 1920-1939 and the correlation turns negative

during 1931-1939. Therefore, as in the post-Bretton Woods periods, carry and momentum

were very different strategies during the interwar years.8

When we include the German mark through 1922-23, returns to all four momentum

strategies significantly increase but the returns to the carry strategy disappear (Table 5). The

abnormally high returns to momentum in 1922 and 1923 reflects the limits to arbitrage since

shorting the mark during these months carried huge country risk. The elimination of the carry

7 The db-xtracker Currency Momentum ETF index goes long (short) the three G10 currencies that have exhibited the greatest (lowest) currency appreciation (against the US Dollar) over the preceding 12 months. Increasing the number of currencies in the sample significantly improves the performance of carry and momentum strategies during the recent period. Menkhoff et al. (2012b) find that a carry trade strategy implemented on 48 currencies over the 1983-2009 period yields a Sharpe ratio of 0.74. Menkhoff et al. (2012a) find a Sharpe ratio of 0.95 for a 1-month momentum strategy implemented on a sample of 48 currencies during the years 1976 to 2010. 8 Menkhoff et al. (2012a) report evidence that the returns to carry and momentum strategies were not correlated in the 1983-2009 period.

15

trade profits by the inclusion of the German mark is consistent with the previous finding in

the recent empirical literature that carry trades incur losses during high inflation events

(Bansal and Dahlquist, 2000).

Finally, Table 6 summarizes the results for the alternative 1 Long-1 Short carry and

momentum strategies when we include the German mark for 1922-23. Whilst the risk-

adjusted performance is similar to that of the 2 Long-2 Short carry and momentum strategies,

returns are higher and the cumulative performance is much stronger (figure 6).

6. Keynes’  performance  on interwar markets

The overall results of the previous section show that carry and momentum strategies

performed well in the interwar years, particularly in the 1920s. The implication is that

currency returns in this period exhibit the same systematic factors that explain currency

returns in the recent past. Despite our discovery in section 4 that Keynes appeared not to

follow such explicit rule-based strategies in preference to relying upon his own analysis of

fundamentals, we proceed to benchmark his performance against these carry and momentum

factors in this section.

Figure 7 displays Keynes’ cumulative profits and losses in sterling pounds from August

1919 to March 1939 and reveals that his strategy of shorting continental European currencies

and going long the US Dollar did not pay off initially. He registered a substantial loss in May

1920 when European currencies temporarily appreciated against sterling, contrary to his

expectations. Thereafter, his currency views were correctly borne out and his strategy yielded

positive returns over the rest of the 1920s. A similar pattern emerges in the 1930s. Initially,

betting against the French franc and Dutch florin incurred losses. However, these losses were

offset when both currencies were devalued in September 1936 and he was left with an overall

profit at the end of the 1930s.

Next,  we  compare  Keynes’s performance with the returns on the carry and momentum

strategies. First, we need to convert his monthly sterling pound profits and losses into a rate of

return. Since he did not operate a fund, we infer the notional equity with which he traded his

currency positions. The archival correspondence with his broker Buckmaster & Moore reveals

that he was required to post a 20 per cent margin on all his forward currency transactions.

Hence,  we  estimate  Keynes’  equity  as  20  per  cent  of  his  maximum  gross  position over 1919-

1927 and then again over 1932-1939. Whilst the assumed level of cover and implied equity

16

affects any estimate of his average return and standard deviation, it does not affect the Sharpe

ratio.

In Table 7, we compare Keynes’s monthly returns with the returns on both the carry and

momentum strategies over the two periods during which Keynes traded and when forward

exchange rates data are available, January 1920 to May 1927 and October 1932 to March

1939. The results reveal that the returns on Keynes’   fundamentals-based trading approach

compared poorly with returns to the carry and momentum strategies (Panel A). Keynes’  mean  

annualized return of +5.40% over the both periods of trading were exceeded by a return of

5.91% on the carry strategy and +7.15%, +6.24% and +8.60% on the three of the four

momentum strategies. Only the MOM6 strategy (+4,51%) did relatively poorly. Furthermore,

the  returns  to  Keynes’  strategy  were  also much more volatile and his Sharpe ratio of 0.16 is

much lower than the Sharpe ratio of the carry strategy (0.57) and of the momentum strategy

which ranged from 0.41 to 0.78.

When we decompose returns into the two sub-periods, Keynes’   underperformance

relative to the carry and momentum strategies is mostly explained by the pattern of returns

during the 1920s (Panel B). However, the carry strategy which did particularly poorly (-

1.75%, Panel C) in the 1930s due to those high-yielding currencies fighting to stay on the

gold standard ultimately capitulating and devaluing their exchange rates. His eventual success

in shorting the FFR and DFL in 1936 enabled Keynes to generate returns of +2.49% and to

outperform the returns to the carry strategy. However, momentum continued to do relatively

well other than over 1 month. Overall, his Sharpe ratio of 0.23 in the 1930s although similar

to that on UK consols was much lower than that on UK equities (0.60).

As we saw in Table 1, out of his 355 trades all but 11 were in five currencies, USD, FFR,

MKS, LIRE, and DFL. Since Keynes did not trade all eight currencies in our sample, we also

estimate returns on the carry and momentum strategies from the restricted sample of these

five currencies. Our findings regarding his underperformance remain qualitatively

unchanged.9

Keynes registered a severe loss in May 1920, when his prediction that European

currencies would depreciate against the US dollar initially proved incorrect (figure 7). The

exclusion his first five months of trading radically boosts his returns to +10.83% and +18.57%

in the 1920s and 1930s respectively (Table 7, Panels D and E). Now we find that he

outperformed the carry strategy (+6.64%, +14.42%) and the best-performing momentum

9 These results are available from the authors upon request.

17

strategy, MOM12 (+8.21%, +12.65%) in both periods. He also did better than UK stocks

(+11.42%, +12.28%) and Consols (+2.29%, +2.67%). His Sharpe ratio also exceeded that on

any other strategy in both periods. We return to discuss this issue below.

Finally,  we  benchmark  Keynes’  performance  by   regressing  his  monthly   returns   against  

the returns on the carry and momentum strategies or factors following Pojarliev and Levich

(2008).

(1)

where CARRY and MOM are the returns on the 2 Long-2 Short strategy among the eight

currencies which are ranked on the forward discount, the increase in value (against sterling)

over either the preceding 1 month (MOM1) or 12 months (MOM12). The results for each of

the whole sample period (Panel A) and the two sub-periods (Panels B and C) are summarized

in Table 8.

The positive and statistically significant coefficient on CARRY in the regressions for the

January 1920-May 1927 period indicates that Keynes tended to borrow in low-yielding

currencies and invest in high-yielding currencies. Indeed, until mid-1924, the US Dollar was

almost always quoted at a discount (against sterling) on the forward market and Keynes

generally went long the dollar. By contrast, continental European currencies exhibited a

forward premium against sterling in 1920-1922 and Keynes shorted them actively. The

positive and significant coefficient on MOM12   also   reflects   Keynes’   belief   that   European

currencies would continue their long-term depreciation against sterling and the US dollar in

the early 1920s. However, the low R-squared for regressions (B1) and (B2) suggests that the

returns on Keynes’   largely fundamentals-based strategy during 1920-1927 cannot be

explained by carry and momentum factors.

Our results for the October 1932-March 1939 period are strikingly different. Whilst the 1

month momentum factor still plays a role in explaining his returns, the coefficient on CARRY

in both regressions (C1) and (C2) turns negative and is statistically significant. This reflects

Keynes’   decision to short the French franc and Dutch florin in 1934-1936. This strategy

contradicts the carry trade since these currencies both exhibited a high forward discount

(against sterling) until their devaluation in September 1936.

Our results indicate that Keynes’   discretionary   approach to currency trading and his

strategy based on the analysis of fundamentals did not perform very well. Of course, his

performance in the 1920-1927 period was substantially undermined by the gigantic loss he

2 1 MOM CARRY R t

18

recorded in May 1920 and benchmarking his returns beginning in June makes his record look

much better. One possible justification for this approach is that Keynes learned how to trade

in these early months and became a more skilled speculator as a result of this experience. Yet,

the evidence from his correspondence dismisses this interpretation. His currency views before

and after May 1920 were unchanged. As a result, we believe there is no particular reason to

exclude the first months of his trading in assessing his performance. From this perspective,

Keynes’   performance   as   a   currency   trader   looks   unimpressive. Following naïve currency

speculation strategies would have allowed him to achieve higher returns in the 1920s while

taking substantially less risk. We also fail to find evidence that Keynes became a more skilled

trader in the 1930s, a period in which returns on carry and momentum strategies were

considerably below those of the 1920s.

7. Conclusion

This paper has provided new evidence on the returns to foreign exchange speculation in the

interwar years when modern spot and forward foreign exchange markets first emerged.

Recent empirical research has persistently demonstrated the returns to simple zero-cost

currency speculation strategies such as the carry trade and momentum during the post-Bretton

Woods era. This result remains a challenge to finance theory and the traditional assumption

that currency speculation is a zero-sum game. However, no studies of the returns to currency

trading in the other era of floating exchange rates in the 20th century have to date been

undertaken. In this paper, we provide evidence that the returns to the same carry and

momentum strategies also existed in the interwar period.

Carry and momentum strategies yielded high returns during the 1920s but lower returns

during the managed float period of the 1930s when currency markets suffered numerous

speculative attacks and sudden devaluations. Overall, carry and momentum strategies

performed similarly or better than UK stocks and bonds over 1920-1939.

By contrast, we find little evidence that the discretionary and fundamentals-based trading

approach of John Maynard Keynes was able to generate substantial profits on interwar

markets. Despite being a major contributor to exchange rate theory and a well-informed

trader, Keynes did not succeed as a currency speculator. His performance over the 1920s was

undermined by substantial losses in May 1920, when the European currencies he had shorted

temporarily appreciated against the US dollar. His record after May 1920 looks much

stronger.   However,   Keynes’   relatively   poor   performance   over   the   whole   sample   period  

19

reflects a recurrent problem of fundamentals-based currency trading, namely, the difficulty in

market-timing.   Keynes’   predictions   about   the   direction   of   exchange   rates   generally   proved  

correct in the medium or long run but he faced difficulties in predicting the more precise

timing of currency movements, as his correspondence in both the 1920s and 1930s reveals.

Overall, these results suggest that currency speculation based on the analysis of fundamentals

is a challenging task.

We believe this paper also opens up an agenda for research. The recent empirical and

theoretical literature on currency trading has proposed several explanations for why carry and

momentum strategies have performed so well in the post-Bretton Woods period. To date, the

literature has been divided between those authors claiming that returns to naïve currency

speculation strategies compensate investors for risk and those claiming that they reflect

transaction costs and limits to arbitrage. We believe these issues should be explored in a long-

run perspective. Understanding why carry and momentum strategies performed well in the

interwar period is a question that should be addressed in future research.

20

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Table 1. Descriptive statistics: JM Keynes’  currency trades, 1919-1939 N is the number of trades. AMT£ is the average value per trade. DAYS is the average duration of the forward trades. Other includes Rupees, Norwegian Krone and Danish Krone.

Source: See text and data appendix.

USD FFR MK LIRE DFL Other AllN AMT£ DAYS N AMT£ DAYS N AMT£ DAYS N AMT£ DAYS N AMT£ DAYS N AMT£ DAYS N AMT£ DAYS

1919-1938 138 9623 128 97 7774 86 41 3144 59 39 6843 98 29 8329 149 11 9099 98 355 8181 1061919-1927 28 12997 77 55 6723 84 41 3144 59 39 6843 98 3 13906 26 11 9099 98 177 7662 801932-1938 110 8764 141 42 9150 88 0 - - 0 - - 26 7687 164 0 - - 178 8698 1321919 10 15334 49 9 11910 34 3 3645 84 6 10550 31 3 13892 26 2 12837 38 33 12185 421920 3 20067 60 10 12058 68 22 3788 47 12 8136 46 0 - - 2 23177 55 49 10062 531921 9 2659 90 4 4339 146 11 3012 77 5 4569 128 0 - - 4 4912 161 33 3543 1071922 1 33296 61 8 3542 123 4 310 61 5 4859 226 0 - - 0 - - 18 4843 1341923 3 16521 146 7 6235 92 1 267 39 6 6604 122 0 - - 0 - - 17 7829 1091924 2 21794 91 11 3204 86 0 - - 2 7368 138 0 - - 3 2806 82 18 5666 921925 0 - - 3 5412 69 0 - - 0 - - 0 - - 0 - - 3 5412 691926 0 - - 3 389 94 0 - - 2 781 97 0 - - 0 - - 5 546 951927 0 - - 0 - - 0 - - 1 2874 91 0 - - 0 - - 1 2874 911932 2 4617 NA 0 - - 0 - - 0 - - 0 - - 0 - - 2 4617 NA1933 5 3143 95 9 5437 93 0 - - 0 - - 2 4453 NA 0 - - 16 4597 931934 17 5615 93 6 9794 92 0 - - 0 - - 2 5063 185 0 - - 25 6574 1001935 28 6677 126 13 10196 94 0 - - 0 - - 10 6710 151 0 - - 51 7580 1231936 21 16453 161 14 10290 79 0 - - 0 - - 12 9477 172 0 - - 47 12836 1391937 14 13087 183 0 - - 0 - - 0 - - 0 - - 0 - - 14 13087 1831938 23 5563 160 0 - - 0 - - 0 - - 0 - - 0 - - 23 5563 160

Table 2. Sample of currencies, January 1920-August 1939

Note: Monthly forward exchange rates are from Keynes (1923) for 1920-1921, Einzig (1937) for 1922-1936 and The Economist for 1937-1939.

Currency Availability

Sterling Pound (GBP) 1/1920-8/1939

US Dollar (USD) 1/1920-8/1939

French Franc (FFR) 1/1920-8/1931; 10/1931-8/1939

German Mark (MKS) 4/1920-8/1923; 11/1923-6/1931

Italian Lire (LIRE) 1/1920-8/1931; 10/1931-10/1935

Dutch Florin (DFL) 1/1922-8/1931; 10/1931-8/1939

Belgian Franc (BFR) 1/1922-8/1931; 10/1931-7/1939

Swiss Franc (SFR) 1/1922-8/1931; 10/1931-7/1939

Table 3. Performance of carry and momentum  “2  Long-2 Short”  strategies, January 1920-August 1939 (German mark excluded in 1922/23)

Source:  Authors’  computations  (see  text and data appendix).    The  table  shows  the  performance  of  “2  Long-2 Short”  carry  and  momentum  strategies  implemented  on  a  sample of eight currencies from January 1920 to August 1939. The eight currencies are the Sterling pound, US dollar, French franc, German mark, Italian lire, Dutch Florin, Belgian Franc and Swiss Franc. The German mark is excluded from the sample between January 1922 and October 1924.

CARRY MOM1 MOM3 MOM6 MOM12 UK STOCKS UK CONSOLA. January 1920-August 1939Mean annualized return (%) 4.49 4.43 4.08 2.63 5.81 3.98 3.01Annualized standard deviation (%) 8.74 9.72 9.27 9.49 9.50 13.77 8.70Skewness 0.14 0.23 0.64 -0.47 -0.50 -0.02 0.38Kurtosis 7.87 7.15 5.90 8.83 7.70 1.17 2.99Sharpe Ratio 0.51 0.46 0.44 0.28 0.61 0.29 0.35

B. January 1920-December 1927Mean annualized return (%) 11.72 10.89 7.82 3.41 12.09 7.17 1.85Annualized standard deviation (%) 12.20 13.03 13.37 13.68 14.12 12.60 6.86Skewness 0.24 -0.03 0.01 -0.79 -0.71 -0.27 0.91Kurtosis 1.64 1.24 1.17 2.69 2.71 1.69 1.58Sharpe Ratio 0.96 0.84 0.58 0.25 0.86 0.57 0.27

C. January 1928-August 1931Mean annualized return (%) 0.59 0.05 -0.11 -0.11 -0.08 -14.43 2.09Annualized standard deviation (%) 0.26 0.36 0.34 0.34 0.30 14.90 7.69Skewness 0.35 -0.79 -0.30 -0.30 -0.72 0.19 0.48Kurtosis 1.15 1.18 1.46 0.19 1.33 0.87 0.29Sharpe Ratio 2.24 0.15 -0.32 -0.31 -0.26 -0.97 0.27

D. September 1931- August 1939Mean annualized return (%) -0.95 -0.03 2.26 3.11 2.24 9.23 4.59Annualized standard deviation (%) 5.72 7.62 5.62 5.93 4.25 13.91 10.64Skewness -5.33 -0.37 4.00 4.11 -1.39 0.17 0.12Kurtosis 37.76 27.72 30.18 33.85 9.97 1.34 2.64Sharpe Ratio -0.17 0.00 0.40 0.52 0.53 0.66 0.43

26

Table 4. Correlation of carry and momentum strategies’ monthly returns, January 1920- August 1939

Source: Authors’   computations   (see   text and data appendix). The table shows the simple correlations between the monthly returns of the five trading strategies of table 3. *: significant at the 10% level, **: significant at the 5% level, ***: significant at the 1% level.

CARRY MOM1 MOM3 MOM6 MOM12A. January 1920-August 1939CARRY 1.00 0.13** 0.08 -0.04 0.17***MOM1 - 1.00 0.73*** 0.56*** 0.57***MOM3 - - 1.00 0.70*** 0.59***MOM6 - - - 1.00 0.69***MOM12 - - - - 1.00

B. January 1920-December 1927CARRY 1.00 0.25** 0.20** 0.10 0.22**MOM1 - 1.00 0.77*** 0.52*** 0.56***MOM3 - - 1.00 0.68*** 0.60***MOM6 - - - 1.00 0.71***MOM12 - - - - 1.00

C. January 1928-August 1931CARRY 1.00 0.06 0.09 0.15 -0.17MOM1 - 1.00 0.55*** 0.66*** 0.18MOM3 - - 1.00 0.57*** 0.28*MOM6 - - - 1.00 0.41***MOM12 - - - - 1.00

D. September 1931-August 1939CARRY 1.00 -0.46*** -0.66*** -0.75*** -0.33***MOM1 - 1.00 0.59*** 0.76*** 0.68***MOM3 - - 1.00 0.83*** 0.44***MOM6 - - - 1.00 0.67***MOM12 - - - - 1.00

27

Table  5.  Performance  of  carry  and  momentum  “2  Long-2 Short”  strategies, January 1920-August 1939 (German mark included in 1922/1923)

Source:  Authors’  computations  (see  text and data appendix).    The  table  shows  the  performance  of  “2  Long-2 Short”  carry  and  momentum  strategies  implemented  on  a  sample  of  eight currencies from January 1920 to August 1939. The eight currencies are the Sterling pound, US dollar, French franc, German mark, Italian lire, Dutch Florin, Belgian Franc and Swiss Franc. The German mark is included in the sample of currencies in 1922 and 1923.

CARRY MOM1 MOM3 MOM6 MOM12 UK STOCKS UK CONSOLA. January 1920-August 1939Mean annualized return (%) -9.22 17.52 18.41 17.61 20.95 3.98 3.01Annualized standard deviation (%) 27.46 27.32 26.75 27.20 27.34 13.77 8.70Skewness -6.89 5.90 6.37 6.16 6.01 -0.02 0.38Kurtosis 65.33 51.77 55.73 53.25 51.33 1.17 2.99Sharpe Ratio -0.34 0.64 0.69 0.65 0.77 0.29 0.35

B. January 1920-December 1927Mean annualized return (%) -21.99 43.08 43.06 40.23 49.29 7.17 1.85Annualized standard deviation (%) 42.53 41.17 40.65 41.49 41.43 12.60 6.86Skewness -4.37 3.78 4.01 3.86 3.73 -0.27 0.91Kurtosis 25.77 21.11 22.09 20.89 20.06 1.69 1.58Sharpe Ratio -0.52 1.05 1.06 0.97 1.19 0.57 0.27

28

Table 6. Performance of carry and momentum  “1  Long-1 Short”  strategies, January 1920-August 1939 (German mark excluded in 1922/23)

Source:  Authors’  computations  (see  text and data appendix).    The  table  shows  the  performance  of  “1 Long-1 Short”  carry  and  momentum  strategies  implemented  on  a  sample  of  eight currencies from January 1920 to August 1939. The eight currencies are the Sterling pound, US dollar, French franc, German mark, Italian lire, Dutch Florin, Belgian Franc and Swiss Franc. The German mark is excluded from the sample between January 1922 and October 1924.

CARRY MOM1 MOM3 MOM6 MOM12 UK STOCKS UK CONSOLA. January 1920-August 1939Mean annualized return (%) 6.93 6.20 8.66 3.99 7.83 3.98 3.01Annualized standard deviation (%) 11.70 12.87 12.63 11.82 13.13 13.77 8.70Skewness 0.87 1.32 1.57 0.76 -0.13 -0.02 0.38Kurtosis 11.28 10.01 10.14 11.73 14.76 1.17 2.99Sharpe Ratio 0.59 0.48 0.69 0.34 0.60 0.29 0.35

B. January 1920-December 1927Mean annualized return (%) 15.99 16.43 14.03 3.76 12.27 7.17 1.85Annualized standard deviation (%) 16.08 17.85 18.11 17.60 19.70 12.60 6.86Skewness 0.65 1.01 0.85 0.50 -0.35 -0.27 0.91Kurtosis 4.70 4.13 4.05 4.49 5.94 1.69 1.58Sharpe Ratio 0.99 0.92 0.77 0.21 0.62 0.57 0.27

C. January 1928-August 1931Mean annualized return (%) 1.10 0.10 -0.05 -0.27 -0.18 -14.43 2.09Annualized standard deviation (%) 0.34 0.48 0.50 0.50 0.47 14.90 7.69Skewness 2.00 -0.94 0.14 -0.27 -0.60 0.19 0.48Kurtosis 6.30 1.24 3.59 0.50 2.83 0.87 0.29Sharpe Ratio 3.26 0.21 -0.11 -0.54 -0.37 -0.97 0.27

D. September 1931- August 1939Mean annualized return (%) 0.53 -1.24 7.28 6.16 7.05 9.23 4.59Annualized standard deviation (%) 8.26 8.74 7.82 5.89 5.87 13.91 10.64Skewness -1.60 -1.67 2.92 2.00 1.93 0.17 0.12Kurtosis 22.32 11.72 12.38 6.92 6.49 1.34 2.64Sharpe Ratio 0.06 -0.14 0.93 1.05 1.20 0.66 0.43

29

Table 7. Benchmarking  Keynes’  returns, January 1920-May 1927 and October 1932-March 1939

Source:  Authors’  computations  (see  text and data appendix). The table compares  Keynes’  performance with the performance of the “2  Long-2 Short”  carry  and momentum strategies of table 3 from January 1920 to May 1927 and from October 1932 to March 1939. The period from June 1927 to September 1932, during which Keynes did not trade, is excluded from the sample.

CARRY MOM1 MOM3 MOM6 MOM12 UK STOCKS UK CONSOL KEYNESA. January 1920-March 1939Mean annualized return (%) 5.91 7.15 6.24 4.51 8.60 6.40 1.84 5.40Annualized standard deviation (%) 10.33 10.81 10.89 11.08 10.97 11.85 7.66 33.11Skewness 0.01 0.56 0.40 -0.53 -0.60 -0.19 0.09 -8.49Kurtosis 4.95 3.77 3.54 6.10 5.55 1.23 2.38 97.26Sharpe Ratio 0.57 0.66 0.57 0.41 0.78 0.54 0.24 0.16

B. January 1920-May 1927Mean annualized return (%) 12.61 11.67 8.58 3.54 13.13 6.18 1.79 7.95Annualized standard deviation (%) 12.62 13.48 13.84 14.19 14.60 12.97 7.06 44.28Skewness 0.18 -0.07 -0.03 -0.77 -0.76 -0.22 0.90 -6.87Kurtosis 0.18 -0.07 -0.03 -0.77 -0.76 -0.22 0.90 -6.87Sharpe Ratio 1.00 0.87 0.62 0.25 0.90 0.48 0.25 0.18

C. October 1932- March 1939Mean annualized return (%) -1.75 1.99 3.56 5.62 3.44 6.66 1.89 2.49Annualized standard deviation (%) 6.23 6.33 5.97 5.85 3.41 10.50 8.35 11.03Skewness -5.01 4.39 4.03 5.57 0.77 -0.09 -0.48 4.20Kurtosis 32.34 33.19 28.43 40.32 2.18 0.16 2.89 27.30Sharpe Ratio -0.28 0.31 0.60 0.96 1.01 0.63 0.23 0.23

D. June 1920- March 1939Mean annualized return (%) 6.64 5.79 4.82 3.99 8.21 6.58 2.29 10.83Annualized standard deviation (%) 10.11 10.49 10.58 9.92 9.82 11.42 7.53 15.34Skewness 0.17 0.57 0.39 0.04 0.04 -0.44 0.10 1.08Kurtosis 5.19 4.54 4.23 5.59 4.10 1.04 2.75 6.39Sharpe Ratio 0.66 0.55 0.46 0.40 0.84 0.58 0.30 0.71

E. June 1920- May 1927Mean annualized return (%) 14.42 9.32 5.99 2.48 12.65 6.50 2.67 18.57Annualized standard deviation (%) 12.31 13.20 13.55 12.60 13.15 12.28 6.74 18.24Skewness 0.37 -0.07 -0.02 -0.40 -0.26 -0.64 1.15 0.16Kurtosis 1.21 1.34 1.25 1.55 1.39 1.43 1.92 2.87Sharpe Ratio 1.17 0.71 0.44 0.20 0.96 0.53 0.40 1.02

Table 8. Regression of Keynes’   returns   on carry and momentum factors, January 1920-March 1939

Note:  Dependent  variable:  Keynes’  monthly  rate  of  return  (in  per  cent) from January 1920 to May 1927 and from October 1932 to March 1939. The explanatory variables are monthly rates of return to the CARRY, MOM1 and MOM12 strategies of table 3. The period from June 1927 to September 1932, during which Keynes did not trade, is excluded from the sample. t-statistics in parentheses. *: significant at the 10% level, **: significant at the 5% level, ***: significant at the 1% level.

Intercept CARRY MOM1 MOM12 N Adjusted R2

A. January 1920-March 1939A1 -0.004 0.838*** 0.778*** 167 0.14

(-0.60) (3.60) (3.50)A2 -0.010* 0.650*** 1.613*** 167 0.36

(-1.67) (3.21) (8.46)

B. January 1920-May 1927B1 -0.012 1.298*** 0.532 89 0.17

(-0.94) (3.70) (1.62)B2 -0.022** 1.051*** 1.595*** 89 0.42

(-2.00) (3.61) (6.33)

C. October 1932-March 1939C1 -0.000 -0.883*** 0.601*** 77 0.57

(-0.13) (-5.16) (3.55)C2 0.001 -1.354*** -0.387 77 0.51

(0.43) (-8.57) (-1.33)

Figure  1.  JM  Keynes’  cumulative  gross  position  (in  £), August 1919-March 1939

Sources: Authors’  computations  (see  text and data appendix).  The  graph  displays  John  Maynard  Keynes’  gross  cumulative position (in all currencies) in £..

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Figure  2.  Keynes’  long and short portfolios (by currency), August 1919-May 1927 (in £)

Sources: Authors’   computations   (see   text and data appendix). The graph shows the currency composition of John Maynard  Keynes’  short and long portfolios (in £) from August 1919 to May 1927. A positive number corresponds to a long position, a negative number to a short position.

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Figure  3.  Keynes’  long and short portfolios (by currency), October 1932-March 1939

Sources: Authors’   computations   (see   text and data appendix). The graph displays the currency composition of John Maynard  Keynes’  short and long portfolios (in £) from October 1932 to March 1939. A positive number corresponds to a long position, a negative number to a short position.

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Figure  4.  JMK’s  positions  and  spot  exchange  rates A. August 1919 to May 1927

1. US DOLLAR

2. FRENCH FRANC

3. GERMAN MARK (1919-1923, log scale)

4. ITALIAN LIRE

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35

Figure  4.  JMK’s  positions  and  spot  exchange  rates B. October 1932 to March 1939

1. US DOLLAR

2. FRENCH FRANC

3. DUTCH FLORIN

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Figure 5. Cumulative performance of carry and momentum “2 Long-2 Short” strategies (December 1919=1), January 1920-August 1939

Sources:  Authors’  computations   (see   text  and  data  appendix).  The graph displays the cumulative performance (December 1919=1) of the CARRY, MOM1 and MOM12 strategies of table 6 from January 1920 to August 1939.

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Figure 6. Cumulative performance of carry and momentum (1 Long-1 Short) strategies (December 1919=1), January 1920-August 1939

Sources:   Authors’   computations   (see   text   and   data appendix). The graph displays the cumulative performance (December 1919=1) of the CARRY, MOM1 and MOM12 strategies of table 3 from January 1920 to August 1939.

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Figure 7.  JM  Keynes’  cumulative  P&L (in £), August 1919 to May 1927 and October 1932 to March 1939

Sources:  Authors’  computations  (see  text  and  data  appendix).  The graph  displays  John  Maynard  Keynes’  cumulative Profits and Losses (in £) from August 1919 to May 1927 and October 1932 to March 1939.

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-34

Aug

-35

Aug

-36

Aug

-37

Aug

-38