Saturday, May 17, 2008

Currency Exchange

In conducting business internationally, if one possesses a foreign currency, and wants to spend business profits at home, the money will need to be exchanged.

Say one dollar buys .7 euros, then if you want 7 euros it will cost you 10 dollars, or if you have 1000 dollars it gets you 700 euros. One euro has more value than one dollar. You can buy more goods with one euro than one dollar, in America at least, after the exchange has taken place. The exchange coefficient (E) is .7 for the euro.

Mainly the currency exchange market serves international trade, but you can try to game it. If you expect the exchange rate to decrease to .5 the next day, and you buy 7 euros for 10 dollars today, and you are right, those 7 euros will get you 14 dollars tomorrow.

So the value of the dollar is the exchange rate multiplied by the value of the euro. V($) = .7*V(euro). If monetary value (V) is inventory (I) divided by money supply (M), then I(us)/M($) = E*[I(eu)/M(euro)]. Or E = [Ius*M(euro)]/[(M($)*I(eu)]. So if the inventory of the US increases, or the money supply in Europe increases, then the change in the exchange rate (delta-E) is positive, so stay away from the euro. If money supply in the US is growing, or inventory in Europe is growing, that’s a good time to consider moving money over to the euro—since the exchange coefficient is falling.

Likewise, if cash value is inventory divided by money supply, then one can estimate relative inventories of different economic systems—if one knows money supplies of both and the exchange rate. Of course, this assumes no errors of pricing and production, and real economies are fraught with them. However I’ll argue they all correct themselves, eventually.

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