Archive for the 'Trade' Category

Nov 23 2011

Why the falling rupee makes Mr. Welker a happy man! (and may help the Indian economy in the long-run)

Indian Rupee hits all-time low against the dollar – CBS News

A couple of years ago I wrote what I would call a “fantasy” blog post about how the recent depreciation of the British pound would have made a ski trip to India a whole lot cheaper since the tour company I was planning to go with quoted its prices in the British currency. Well, at the time I wasn’t really planning to go skiing in the Himalayas, but this year, because of a fall in the value of another currency, I really AM going to ski in the Himalayas!

The chart below shows how the value of the Swiss franc has changed against the Indian rupee over the last year and a half.

The Value of the Swiss Franc in terms of India Rupees – last 18 months


As can be seen, the franc, which is the currency in which I get paid here in Switzerland, has risen from only 40 rupees 18 months ago to as high as 63 rupees in August this year, and is currently at 57 rupees per Swiss franc. We’ll explore the underlying causes of this appreciation of the franc in a moment, but first let’s examine its effect on my dream of skiing in the Himalayas.

So just yesterday morning I did, at last, after six years of dreaming of this adventure, book a six day guided ski trip in the Indian Kashmir town of Gulmarg, which sits at an elevation of 2800 meters and has lift-accessed skiing up to 4,000 meters, making Gulmarg the second highest ski resort in the world. Okay, enough facts. The strong franc made this trip a reality for me for the following reason:

  • 18 months ago, the 40,000 rupee price tag of this ski trip would have meant a cost of 1,000 swiss francs.
  • Today, due to the strong franc, the 40,000 rupee price tag means this trip is only costing me 700 swiss francs.
Due to the strengthening of the franc, and the weakening of the rupee, my Himalayan ski odyssey is now costing me 30% less than it would have 18 months ago… so… I’m doing it! YEAH!
The Swiss currency has appreciated by 42.5% in the last 18 months against the India rupee. WHY?! What could be going on in the world that accounts for this massive swing in exchange rates? There are a few causes worth mentioning here, which have to do with factors within Switzerland and India, but also external factors beyond the control of either country. Here are some of the major ones:
In Europe:
  • The franc has risen against most world currencies, not just the rupee, due, ironically, to economic uncertainty in the rest of Europe. Since Switzerland has its own currency, and a strong economy, whereas all of its European neighbors have a common currency (the euro), and struggling economies, investments in Swiss assets (primarily savings accounts and government debt) have become increasingly attractive. This has caused demand for francs to rise, causing its value to increase against most currencies.
  • The debt crisis in the rest of Europe, most notably in Greece and Italy, reduces certainty among investors in these European governments’ ability to repay their debt, creating further demand for investment in Switzerland, causing the franc to rise.
In India:
  • According to the Associated Press, “Slowing growth, a swelling current account deficit and waning investor interest in India are adding to pressure on the rupee…” India runs a large trade deficit, equaling about 3% of the nation’s GDP. This means Indians are dependent on imported goods, while foreigners do not demand as many of its exports. This puts downward pressure on the exchange rate of the rupee.
  • In addition, the “slowing growth” rate in India sends the signal that the country’s central bank may lower interest rates to try and stimulate GDP. However, the expectations of lower interest rates in the future make international investors look elsewhere for investments with relatively higher returns.
  • Next, weaker growth prospects make investments in Indian assets (such as corporate stocks or bonds) less attractive to international investors, since they expect demand for Indian output to slow in the future, thus demand for rupees declines now.
  • Finally, the decline in the rupee’s value itself is fueling a further increase in the value of the franc. Not all currency exchanges are for the purpose of purchasing a nation’s goods or its assets. Much currency trading is among forex brokers who buy and sell currencies to hold as assets themselves. The weakening of the rupee may be fueling speculation about the future value of the rupee, which acts as a self-fulfilling prophecy, as forex investors will continue to swap rupees for other currencies, including the Swiss franc.
All this adds up to one thing for me: A 30% discount on my ski vacation to India! Of course, for the Indian economy, a weaker rupee might be just what is needed to boost future economic growth. As the rupee falls and the Swiss franc and the US dollar gain value, not only will ski vacations to India become more attractive to foreigners, but so will other exports from the South Asian nation. That 3% trade deficit that has contributed to the rupee’s decline may begin to move towards the positive if foreigners like me begin taking more trips to and buying more goods from Indian firms.
The weaker rupee could, in the long-run, increase total demand for India’s output, which would improve employment and growth prospects on the sub-continent. Furthermore, if India’s growth rate picks up due to increased net exports, the Indian central bank may be able to raise interest rates a bit, reducing the incentive for investors to flee the rupee and put their money in countries with higher returns.
Through this process of self-balancing, in time the weaker rupee will probably lead to an improvement in India’s economic situation and eventually the rupee will begin to strengthen against the currencies of India’s trading partners. But for now, I’m going to enjoy my week of guided skiing in the Himalayas, and thank the forex traders and currency speculators for allowing me to take this dream vacation for such a bargain price!

courtesy: http://www.gulmargpowderguides.com/

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Oct 28 2011

How China’s demand for coal may help make America greener, or not…

The Global Coal Trade’s Complex Calculation : NPR

Sometimes when I read the news, I wonder what it would be like to NOT understand basic economics, and then I realize how much of what goes on around us can be explained by two simple concepts: demand and supply. The NPR story below talks about how the construction of two proposed coal exporting facilities on America’s west coast could, indirectly, lead to a greener future for America. Listen to the story then read on for more analysis:

China, already the world’s largest coal consumer, continues to build new coal burning electricity plants at an alarming rate. Its appetite for the “black gold” has driven the world price up to $100 per ton, as it has demanded increasing quantities from its own coal producers, but also those in other coal rich areas like Australia and the United States.

However, because of America’s lack of coal transporting and shipping infrastructure, US coal producers have been unable to sell their abundant coal to the Chinese, who are willing to pay 500% the equilibrium price in the US. The US market has remained isolated from the world market, not due to any explicit, government-imposed barriers to trade, rather due to fact that they simply can’t get their coal to the Chinese energy producers who demand it most.

Graphically, this situation can be illustrated as follows:

If the export facilities on the West coast of the US are not constructed, it will remain difficult for US coal producers to sell their output to China at the high price of $100, and the domestic quantity (Q2) will continue to be produced and sold for $20 per ton. But with the new port facilities, US energy producers will now have to compete with Chinese energy producers for American coal, and the US price will be driven up to the world price, since demand now includes thousands of Chinese coal-fired power plants. As the price rises from $20 to $100, the domestic quantity demanded in the US will fall to Q1, as domestic energy producers seek alternative sources of energy, switching instead gas, solar, or wind power.

The irony is that through increasing the ease with which American coal producers can sell their product to China, the US may reduce its own consumption of coal and its emissions of greenhouse gasses. Overall coal production in the US will rise with increased trade, but overall consumption within the US will fall.

Now, this may sound great if you’re the kind of person who thinks only locally. Air pollution will be reduced in the US, health will be improved, our electricity production will be greener and more sustainable. But globally, by making its coal available to China, the US market will contribute to the continued dependence on carbon-intensive energy production, and delay any progress among Chinese energy producers towards a transisttion to greener fuel sources.

The podcast also points out the fact that if the US did undertake the construction of the new coal-exporting facilities, it could be that the current high price of coal will have led to the entrence of several other large coal prodcuing countries into the world market, reducing China’s demand for US coal, reducing the price at which American producers can sell to China and thereby off-setting any domestic environmental benefit that may have resulted from the large decrease in quantity demanded among US producers at the current price of $100 per ton.

The whole conversation about the coal industry is somewhat depressing when the environmental costs of the industry are considered. Another NPR show, Planet Money, ran a story this week about the “gross external damages” caused by the production of coal-powered electricity.

They cited a study which found that the damages caused by coal to human health and the environment outweight the benefits enjoyed by society from the generation of cheap electricity by around $10 billion in the United States alone. This means that if the US shut down every coal-powered energy plant in the country immediately, total welfare in the US would increase by $10 billion. There’s no doubt that energy prices would rise, but the gains in human and environmental health would outweight the added costs of electricity generation by $10 billion. If a similar analysis were undertakein in China, I would guess the potential welfare gain of transitioning to alternative energies would be far greater for the Chinese people.

Here’s the chart from Planet Money’s blog showing the net welfare loss of coal-generated electricity and other economic activities in the United States.

*GED = Gross external damages from pollution

Notice that although generating electricity by burning coal adds nearly $25 billion of value to America’s economy, its negative environmental externalities create nearly $35 billion in damage to the US economy. The net effect of using coal to make electricity, therefore, is around -$10 billion. America would be better off without coal-generated electricity, if we include environmental and health factors in our measure of well-being. Unfortunately, the negative environmental and health costs of coal-electricity generation are currently externalized by the industry, indicating that this industry may be experiencing a market failure.

Discussion questions:

  1. How would the construction of two coal-exporting facilities on America’s West coast ultimately lead to a cleaner environment in the United States? Do you think this prediction is realistic?
  2. Who stands to gain the most if the coal-exporting facilities are constructed? Who would suffer? In your opinion, should the facilities be constructed? Why or why not?
  3. Interpret the colorful diagram above. What do the green bars represent? What do the yellow and red bars represent? According to the graphic, which type of activity is most harmful to American society? How do you know?
  4. True, false, or uncertain. Explain your reasoning. “The burning of coal to make electricity should be completely banned in China, since China is the world’s largest greenhouse gas emitter.”

One response so far

Sep 29 2011

Protectionism’s many weaknesses

After our lesson on tariffs and protectionism the other day, one of my year 2 IB Econ students emailed me with a few questions she had not had the chance to ask in class. I thought I’d post my responses here, since they were such good questions!

Question: Hi Mr Welker, I asked this on Monday’s blog about self-sufficiency, but no one answered my question and I have been meaning to ask this in class but I always get distracted and I forget. And perhaps you have already answered this, pardon me if you have.

Since Exports and Investment have a great effect on economic growth, why would a government want to protect its nation by imposing barriers to trade? Because by doing so, foreign firms cannot invest in that nation and potentially create job opportunities and also contribute to that nations GDP since, even though it’s a foreign investment, the revenue is collected by that government.

Answer: Protectionism is not typically aimed at reducing the amount of exports from the nation engaging in it, rather reducing the amount of imports or promoting increased exports. You’re exactly right that exports and investment contribute to aggregate demand (and therefore economic growth and employment) in a nation. But imports are a ‘leakage’ from the nation’s economy, and the greater the level of import spending, the lower a nation’s net exports. A nation with a trade deficit actually experiences negative net exports. The purpose of protectionism is to reduce import spending, or increase export revenues, and thereby increase net exports and aggregate demand and employment in the nation.

As for foreign investment, one of the consequences of a large trade deficit is increased foreign ownership of domestic resources or factors of production. Since a country that imports more than it exports spends more on foreign goods than it earns from the sale of its own goods to foreigners, foreign governments and firms end up with large amounts of that country’s money that is NOT being spent on that country’s goods. Much of this ends up back in the deficit country as foreign investment. Sometimes foreigners will buy government bonds (invest in the deficit country’s debt, in other words), but sometimes the money comes back home as foreigners buying up factories and real estate. Foreign investment may indeed help create jobs at home, but so does domestic investment, and when foreigners invest it means the country’s resources are now owned by interests abroad, which many countries view as a threat to their national and economic security. This can also serve as a justification for protectionism: to prevent foreign ownership of domestic assets.

Question: Also if the country is not exporting, it’s not enjoying the benefits of revenue from exported goods that could boost their economic growth. And anyway, isn’t the point of making money to spend it? Otherwise what is the incentive of being employed and earning an income? Unless of course, one can argue that income earned can then be spent on domestically produced goods.

Again, the purpose of protectionism is not to reduce a country’s exports, rather to reduce its imports and to increase its exports. But you have made a very important observation here that points to a major flaw in the argument for protectionism. The purpose of exporting goods it to make money to spend on imported goods, otherwise, WHY TRADE? A country gains from trade not only because it has a wider market for its own goods, but because the people of the nation have a wider market from which to choose the goods they themselves can consume. When a nation erects barriers to trade, it will ultimately have the effect of reducing not only imports, but possibly the nation’s own exports. Since foreigners earn less money from selling goods to the protected nation, they have less money to spend on that nation’s goods!

All protectionism can hope to do is increase the welfare of particular industries while reducing the welfare of the rest of society. It is rarely justifiable on the grounds that it will increase the total welfare of society as a whole, unless of course the protected industry is one vital to national security, such as the defense sectors or the energy sector (even this one is debatable!)

Question: Or do government spending (through subsidies, and creating job opportunities) and increased consumption due to income gains caused by government intervention overcome these factors and compensate for the lost opportunity of exports and investments.

Increasing government spending to off-set the fall in social welfare resulting from protectionism will only lead to greater inefficiency in society. Government may have to spend more on unemployment benefits for workers whose jobs are lost due to protectionism, which may require higher taxes on those workers whose jobs are being protected. As explained above, one industry’s gain leads to a loss of welfare for society as a whole. This is the problem with protectionism. It favors certain industries but imposes higher prices on consumers and higher costs of production on other industries. It should not be the government’s job to “pick winners and losers” in the global economy. By protecting certain industries, however, government attempts to do just that, but society as a whole loses.

I hope you understand what I am asking for here. Whenever you have time, I would love to hear your perspective.

Maphrida

Great questions, Maphrida!

Discussion Questions:

  1. How might protectionism lead to an increase in aggregate demand and domestic employment?
  2. Why does a large trade deficit lead to a build-up of foreign ownership of domestic factors of production?
  3. Discuss the view that protectionism in the form of tariffs on particular goods helps certain industries but harms the rest of society. Can you imagine an example of a protectionist policy that could increase the welfare of society as a whole?
  4. Explain how a protectionist policy that makes imports more expensive and thus reduces demand for imported goods can ultimately lead to a reduction in demand for the protected country’s exports abroad.

6 responses so far

Sep 12 2011

If Iceland can get rich, anyone can!

CIA – The World Factbook – Iceland

How did a barren rock in the middle of the North Atlantic Ocean become one of the richest countries in the world, where the average citizen earns $40,000 per year?

Iceland’s prosperity is a perfect example of how a country that participates in international trade based on the principal of comparative advantage can produce the goods for which it has a relatively low opportunity cost, export them to the rest of the world, and become rich. Listen to the podcast below, then complete the activity that follows.

Activity:

  • Go to the CIA World Factbook online.
  • Look up your home country from the drop down menu.
  • Click on the “Economy” section and read the introduction to your nation’s economy.
  • Look through the economy section and find information on your nation’s exports, then answer the questions that follow.
Questions: 
  1. What is the value of your home country’s exports (in dollars)?
  2. What are the main exports from your country to the rest of the world?
  3. Calculate the percentage of your nation’s GDP is represented by exports (divide the dollar value of exports by the dollar value of GDP, and multiply by 100).
  4. What types of goods does your country export? Are they land-intensive? Labor-intensive? Capital-intensive? Discuss why your country exports what it does to the rest of the world.
  5. What does your country import? What is the dollar value of your country’s imports? What is the percentage of your country’s GDP made up of imports?
  6. What is greater, the value of imports or the value of exports in your country? What does this mean for your nation’s “circular flow” of income?
  7. Referring to the principal of comparative advantage, discuss the composition of your nation’s exports and imports. What types of goods or services do you think your nation has a comparative advantage in? How can you tell?

45 responses so far

Sep 06 2011

Stability – the greatest Swiss virtue?

BBC News – Swiss National Bank acts to weaken strong franc

The Swiss pride themselves on their long history of stable democracy, domestic tranquility and international neutrality. The stability of the Swiss state and the Swiss economy is heralded as one of its greatest virtues. But in the last few months, particularly in the first two weeks of August, instability has been more the norm in the Swiss economy due to the rapid appreciation of the Swiss currency, the franc, against the euro and the US dollar, which I blogged about here a couple of weeks ago.

Well, as of this morning, the franc’s ascent looks like it has reached its end, and the value of the franc is set to be pegged at 1.20 francs per euro (or 0.83 euros per franc), which is about 8% below what it was trading at this morning.

The Swiss National Bank (SNB) has set a minimum exchange rate of 1.20 francs to the euro, saying the current value of the franc is a threat to the economy.

The SNB said it would enforce the minimum rate by buying foreign currency in unlimited quantities.

The move had an immediate effect, with the euro rising from about 1.10 francs before the announcement to 1.21 francs.

In a statement, the SNB said: “The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

“The Swiss National Bank is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20.

“The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.”

Against the franc, the euro climbed 9%, the dollar rose 7.7% and sterling gained 7.8% within minutes of the announcment.

NPR’s Planet Money reported on the story from Berlin here:

The instability resulting from the franc’s 30% rise in the value against other major currencies throughout the year is primarily the effect it has had on Swiss exporters. Foreign consumers, who actually buy about 50% of Switzerland’s output, have seen the prices of Swiss goods rise as the value of their own currencies has declined against the franc, reducing demand abroad for Swiss exports, forcing firms in the Swiss export sector to reduce their labor force and otherwise cut costs to compensate for the falling demand for their products. The threat of rising unemployment and falling demand for its output caused the Swiss National Bank and the Swiss government great concern, leading to today’s announcement.

The “deflationary development” mentioned by the SNB refers to a situation in the Swiss economy where the strong franc makes imports appear ever more attractive (and cheaper) to Swiss consumers, and Swiss goods increasingly less attractive to foreign consumers, reducing the demand for Swiss goods overall and forcing Swiss firms to lay off workers and lower their costs and prices to compensate for falling demand. Lower prices for goods and services in Switzerland reduces the incentives for firms to invest in new capital, thus reducing the demand for labor further, threatening to push the Swiss economy into a demand deficient recession. Deflation, defined as a persistent fall in the average price levels of a nation’s goods and services, can result in a downward spiral characterized by rising unemployment, falling demand, lower prices, and increased layoffs in the export sector, further exacerbating the unemployment problem.

The SNB’s decision to peg the franc to the euro will assure that foreign consumers of Swiss goods will not see their prices continue to rise, and Swiss consumers of foreign goods will not see them get any cheaper in coming months, hopefully bringing Swiss households who have recently enjoyed cheap imports back to the Swiss market to buy more Swiss-made goods and services.

Personally, I have mixed emotions about the franc’s peg with the euro. Of course, on one hand I have benefited greatly from the stronger franc, as an American working in Switzerland, earning swiss francs, the stronger currency has meant I can send the same amount of francs home as I always have, but it has translated into larger and larger quantities of dollars. Today, the dollar’s value has risen nearly 8%, meaning this month I will have a bit fewer dollars in my savings account in the United States as I would have before the peg.

As an employee in a Swiss firm, however, my continued employment depends on the continued demand for the service my school is providing, which is education to the children of multi-national corporations operating out of Switzerland. If the franc had continued to rise, the incentive for multi-nationals to locate their offices in Zurich would have become weaker over time, and more firms would have chosen to move their international employees to cities like Paris, London or Frankfurt, reducing demand for my school’s services and threating my own employment and income, just as those workers at other Swiss export firms’ jobs have been threatened in recent months.

Stability is a virtue the Swiss have always prided themselves on. Today’s announcement by the Swiss National Bank will bring greater stability to the Swiss economy, despite the disadvantages it brings to individuals who have enjoyed the benefits of a stronger franc in recent months.

The graph below explains how the SNB will enforce its currency peg against the euro:

Discussion Questions:

  1. How will the weaker Swiss franc help the Swiss economy?
  2. How will certain individuals in Switzerland be harmed by the weaker franc?
  3. How might the weaker franc affect demand for enrollmente at Zurich International School?
  4. What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
  5. Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?

16 responses so far

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