A new sheriff in town.

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Currency Trader, Police Thyself

Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to the Bloomberg View. Follow him on Twitter at @smihm.
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Last week, a working group at the Bank of International Settlements issued a new code of conduct governing global currency trading, a response to the most recent price-fixing scandal in the foreign-exchange markets.

The document contains non-binding “principles” that are entirely voluntary -- general guidelines for good behavior. Cynics could be forgiven for dismissing this as an empty gesture that lacks the coercive rules and punishments required to make global standards stick.

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Yet history suggests that these kinds of arrangements can be fruitful. For more than a century and a half, increasingly large swaths of the world’s economy have been governed -- at least initially -- by such voluntary standards. Many of them have been subsequently endorsed by national governments and multinational bodies, giving them the force of law. They’re often an important first step in filling a regulatory void.

The idea of using voluntary standards to govern behavior arguably began in the 19th century, when the need to coordinate economic activity across previously separate, isolated locales became a serious challenge. Companies in individual countries -- and eventually, around the world -- insisted on clinging to different, incompatible standards, making it hard to do business.

The most famous example is the railroads. For a time they relied on varying track gauge, which made it difficult to connect neighboring networks. More problematic still, they organized train schedules according to local, solar time: every town and city throughout the world was effectively in its own time zone. This made coordinating traffic across increasingly entangled, interdependent networks of rail almost impossible.

In the U.S, the federal government could have stepped in and mandated standard track gauge and time zones. It didn’t. Instead, the railroad corporations hammered out a solution on their own. These weren’t binding agreements, but they nonetheless did much to ensure compliance with the new consensus. Most of the nation’s railways converted to a uniform track gauge; likewise, they almost universally adopted a new set of standard time zones that are still the norm today.

In time, a host of national and international congresses established voluntary, consensus-based agreements on standards for everything from the size of ball bearings to units of electrical resistance to standard definitions of colors used in consumer goods.   

Organizations undertook these campaigns of standardization with the blessing and even the sponsorship of national governments. They often worked closely with newly created standards bodies: the British Standards Institution in the U.K.; the Normenausschuß der deutschen Industrie in Germany; the American Bureau of Standards; and so on. And national governments often formally endorsed the standards set by these bodies.

But much of the impetus for the standards themselves -- never mind the heavy lifting required to agree on them -- fell to the private sector: industry groups or engineering associations. These in turn would send representatives to new, global standards-setting bodies and congresses that transcended national borders: the International Electrotechnical Commission; the International Standards Association, and its successor, the International Organization for Standardization, which today wields a staggering amount of power over the global economy.

To be sure, getting a critical mass of market players to adopt a standard ball bearing is far easier than finding consensus on more diffuse and difficult matters such as a common code of behavior or ethics. But here, too, history offers some reassurance.

Take the nasty business of war making. Today, almost every nation in the world has signed on to the so-called Geneva Conventions. But it is often forgotten that this set of humanitarian principles began when a private body -- the forerunner to the International Committee of the Red Cross -- convened a congress designed to create an international, voluntary consensus governing the rules of war.

But for most of the 19th century, most attempts to establish codes of conduct occurred within national organizations focused on more mundane matters than war and peace. A survey published in 1926 found no less than 124 ethical codes adopted by a range of national organizations, from the National Association of Straw Hat Manufacturers to the National Association of Peanut Butter Manufacturers. When members of these organizations failed to comply with the codes, they could seek recourse through the national bodies that promulgated these codes.

It was only a matter of time before international organizations followed suit. In 1937, the International Chamber of Commerce promulgated its Code of Standards of Advertising Practice, which national chambers of commerce throughout the world soon adopted. The new code articulated guidelines for what constituted good advertising practice and discouraged the disparagement of competing products by name -- a principle that most advertisers continue to embrace. In the succeeding decades, many other international organizations reached similar agreements.   

And there's evidence that these voluntary arrangements have some sway over behavior. In fact, they are often welcomed by industry because they help banish ambiguity, establishing much-needed rules of the game, sanctioning certain behaviors and forbidding others. The organization issuing the rules typically can censure members who fail to comply with them, even denying them a seat at the table when other important decisions must be made.

There are cases, of course, where there is no obvious body governing a given industry. There is no international association for currency traders. That’s why the Bank for International Settlements, which represents the world's biggest central banks, got involved.  The BIS and two working groups -- one made up of representatives from central banks, the other drawn from the private sector that included 35 of the biggest players in the $5.3 trillion-a-day global currency market – spent eight months drawing up the new code.

It’s tempting to conclude that the often reckless, corner-cutting gamblers who make their money in currency markets will simply ignore the new code. But if the past is any guide, this is one set of rules that may eventually get their attention.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Stephen Mihm at smihm1@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net