As a result this blog is likely to get pretty busy. Stay tuned!

.zip (20 KB)

http://www.eclectricity.com/StockForex.zip

• You’ll need Excel 2007, and the MSN Money Central addin for Excel to view this document correctly.
• You’ll also need to enable macros after opening the document

To refresh your stock and currency quotes, click on the Data Tab, and then click “Refresh All”.

The currency tab will handle dollar buy/sell transactions, as well as cross-rate transactions. A cross-rate calculator is included.

To insert a new trade, simply move to the last row of any table and press TAB to insert a new line.

Profit/Loss is automatically calculated based on your entered purchase data and the current price.

Note that for stock transactions, you must enter the ticker symbol manually, but for currencies you can select from a list of major currencies.

One additional note, apparently MSN Money Central feels that Euro/Yen transactions need to be calculated in 100′s of Yen. As a result you’ll find that the cross rate for these currencies needs to be mentally moved 2 decimal places to the left. (e.g. 1.34 becomes .00134)

Now with all that good info in mind, I’ll share another wonderful tool with you.

EverBank.com allows account holders to purchase foreign currencies at spot rate plus a small transaction fee in an FDIC insured account. Base amount to establish an account is $2500 US, but account holders can move their savings between currencies within a single account to take advantage of forex opportunities, and still collect interest on the savings (for deposits of $10,000 or more). I think this is a wonderful idea. To learn more click here.

Happy Trading,

There are an uncountable number of factors that have lead to dollar weakening over the last 20 years: introduction of the Euro, ever increasing US imports, increased US national debt and government spending, free trade agreements of all sorts, Internet commerce, and globalization, just to name a few.

The important question then becomes is this a good thing? The answer depends on who you’re asking and when you’re asking them.

Just last Friday, Saudi Prince Turki al-Faisal, wrote in an article that “The United States has no alternative to oil to meet its massive energy needs and should recognize its energy interdependence with the Middle East“.  Critical to understanding the implications of this statement is the fact that oil is currently priced in dollars. If the value of the dollar decreases, the cost of oil increases inversely for all nations which use the U.S. dollar as their currency (and there are several, including Cuba, although in that case unofficially).

For nations which use other currencies however, there’s a relative change in the price of oil as the dollar depreciates. To use the Euro for a moment, the Euro/Dollar exchange rate is currently $1.462. The price of oil is currently $72.32, and therefore the price of oil for countries in the Euro zone is €49.46.

(72.32/1.462=49.46)

 On March 4th of this year the Euro/Dollar was 1.254 and oil was priced at approximately $55 a barrel. In terms of Euros, that means the price of oil, denominated in Euros, was €43.85.

(55.00/1.254=43.85)

So how is it that a 6 euro increase in the price of oil translates to a 17 dollar increase for the same commodity? For my American car loving friends, this should have caught your attention.

In practice, the price of a currency is dependent on five factors:

1. Changes in Relative Inflation Rates
2. Changes in Relative Interest Rates
3. Changes in Relative National Income
4. Changes in Government Controls
5. Changes in Expectations

This alone is insufficient to really analyze the current situation however. We also have to look at GDP, which is comprised of four factors:

1. Consumer Expenditures
2. Gross Domestic Investment
3. Government Purchases
4. Net Exports

 Let’s take a look at GDP first.

• There has been a decrease in Consumer Expenditures ($133.4 Billion 1Q 2009) and Domestic Investment (down 1% 2Q 2009).
• There has been an increase of Government Purchases. ($1.5 Trillion in TARP/TALF funds and Economic Stimulus)
• There has been a decrease in Net Exports. ($-101.5 Billion 1Q 2009, down from $-154.9 Billion 4Q 2008) [Bureau of Economic Analysis]

 The net effect of this trend was a 1Q reduction in GDP of 6.4%, and 1% in 2Q.

In particular, although Net Exports decreased 50% between 4Q and 1Q, the U.S. still imports more than it exports, or said another way, the demand for dollars continues to decline. With fewer dollars in demand, this increases the price of goods imported to the US and hence we have $72 bbl oil.

Although a metric I’ve not seen used anywhere before, I think it’s important to consider the net effect of imports as a proportion of consumer expenditures.  Net Exports (or really net imports) were 76% of Consumer Expenditures in 1Q. 

 (101.5/133.4=.76)

Even more critical is the idea that this is a measure of gross imports. Total imports for 1Q was $373.4 Billion. If we compared this figure against Consumer Expenditures, the rate is 284%.

With that in mind, the US has some serious questions to consider about its future, but it’s clear that this trend is unsustainable in the context of the global economy, even though an inflection point was reached in 1Q.

Returning to exchange rate factors, there has been considerable debate about whether the US has avoided serious inflation or serious deflation. In the longer term, unless the US garners some discipline over its spending, production, and trade habits, the country faces the threat of increased inflation. Although the Volatility Index (^VIX) has subsided from a high 80 late last year, to a more manageable 25 currently, this only suggests that the country is expecting a sustained decline in the value of the dollar. This isn’t to say the US is the only country in the fiscal lifeboat. A report I read some time last year estimated consumer debt in the UK was 105% of GDP.

Interest rates remain remarkably low all things considered. As we well know however, the ability to obtain loans is substantially diminished. It’s no wonder that interest rates remain low so long as the eligibility to obtain loans remains strict. In the current environment, the Fed and Treasury have a fine path to walk in managing the availability of credit relative to interest rates. Making more people eligible for loans increases risk, and therefore interest rates. Fail to make enough credit available, and both investment and savings decrease.

National Income for the US will likely diminish for the 2009 year, further reducing the country’s Purchasing Power. It’s precisely here where I think the Blue Dog Democrats have it right over most Republicans and several Democrats, in so much as purchasing power is a direct function of the ability to pay for goods and services. If our annual tax revenues are roughly $14 trillion, and the country spends $16 trillion, the purchasing power of the country will be substantial for that year, but in the subsequent years the $2 trillion dollar debt becomes a cumulative weight on national purchasing power; inclusive of both the balance of the principal and the interest. Government bonds have been trading with extremely low yields for more than five years. Even 30 year long bonds are trading at less than a 5% yield. Certainly the risk of covering a 30 year bond in the current economic environment should warrant more than a 5% ROI, but the Fed and Treasury have made a point of trying to supplant interest rates in order to encourage borrowing. This does not however encourage lending. As late as two years ago there were rumblings across the world about removing or diminishing the power of the dollar as the world’s reserve currency, and although in the end I think this is a necessary step to the peaceful continuance of global trade, this doesn’t mean that the US shouldn’t try to bolster the attractiveness of the dollar and American exports.

As a result of the Great Recession, there have been substantial changes in government controls world wide, but with specific respect to the US, new calls for financial regulation will reduce capital flows in the short term. The benefit to this action however is a much more sound platform from which future capital transactions can occur. Done well, and I expect global real GDP growth could reach between 4 and 7% annually by 2012, and US real GDP growth between 5 and 8%.

The net effect of expectations on dollar values relative to other currencies is continued depreciation over the next few years. The opportunity the US has here is increasing its exports. As the cost of dollars declines, the attractiveness of US goods increases. This should be considered an opportunity for companies to shift some labor and manufacturing to the U.S. It should be particularly and increasingly attractive for foreign companies to hire US labor because the cost in their currency to hire US labor will be reduced.

With that in mind, US companies need to innovate and find new markets for new goods. The challenge US companies will face is the direct disadvantage of working in an environment with diminishing dollar/dollar exchanges (as opposed to, for example, Euro/Dollar exchanges). That is to say, because there’s no translation exposure to the benefits of a depreciated dollar for US companies in sourcing US labor and supply, they have to survive on the value of the dollar as it is. By the same token however, US companies have a substantial opportunity to take advantage of the depreciated dollar in terms of foreign sales.

What may go missing in this conversation, and shouldn’t, is the current increased deviation of currency risk. The spread of currency risk is more volatile for the US than perhaps it’s ever been. Some of this risk has already been priced into the value of the dollar relative to other currencies, but it’s not something to be ignored by any government or person. Stable governments and lasting peace rely on stable financial systems and trust. To that end, the side effects of the bitter pill the US swallowed last November will be felt for some time to come, but that’s no reason to ignore the doctor’s prescription for fiscal health.

To explain Comparative Advantage, one must first understand Absolute Advantage, which essentially says that  a person, Country, or other entity produces some good at a lower total cost than some other entity. By contrast, Comparative Advantage says that an entity can produce a good more efficiently relative to another entity in terms of opportunity and marginal costs.

What does this mess of terms really mean?

Let’s assume I’m from Country X, and I produce coffee really well; so well in fact that none of my neighbors can produce as much coffee as my Country can at the same low cost. This is Absolute Advantage.

But what if I have a lot more coffee than I can use, but at the same time a shortage of wheat? I can stay awake all night long, and never miss an appointment, but I don’t have enough bread to eat because I’ve used all of my fields to grow coffee.

There may be a lot of reasons why Country X has so much coffee and is so efficient at producing it, and equally why there’s a wheat shortage. Coffee grows well on hills and mountains, while wheat does much better in warm fields for example. If Country X can’t produce all the wheat it needs, then it must trade with some other entity that has wheat available. Or, perhaps the sale of coffee has such high profit margins that the ruler of Country X selected to produce more coffee at the expense of wheat, or said another way, the ruler’s choice to produce more coffee has forced an opportunity cost against the productive capacity of Country X’s ability to produce wheat.

But what if that ruler really wasn’t quite as mad as they initially appear?

Enter trade.

Now imagine Country Y has a wheat surplus in much the same manner that Country X has a surplus of coffee. Country Y’s citizens make wonderful breads, but can’t seem to work more than a few hours because they have a shortage of coffee. Country Y also has a geographical problem in so much as their Country is really flat and hot, and coffee doesn’t grow well there. They could use the production possibilities curve to determine how many wheat fields they would have to sacrifice to produce the coffee they need, but it might be too substantial and cause the citizens to starve.

Meanwhile Country X’s citizens are starving because they not only don’t have enough wheat to make bread from, and their local witch doctor has discovered that coffee is a diuretic stimulant that aggravates hunger and starvation. Country X could sacrifice some of their coffee fields for wheat fields, but would it be too much?

So what happens if these two countries elect to trade coffee for wheat and visa versa?

Country X is in dire need of wheat, so the ruler is happy to trade coffee for wheat. Country Y would like some coffee so that its citizens can stay awake long enough to cultivate the entire wheat harvest.

Here’s where it starts to get a little complicated.

The first question is how much coffee needs to be exchanged for wheat to satisfy Country X’s food needs, and alternatively how much coffee does Country Y need to keep its citizens awake?

One could also argue that Country X has a greater need, because its citizens are already hungry, so does this mean that Country Y’s ruler could take advantage of Country Y’s problems? Perhaps, but the point here is that the amount of goods required by each Country will largely determine the price of the trade. That is to say, Country X needs a certain number of bushels of wheat to satisfy its citizens, while Country Y needs a certain amount of coffee to satisfy its citizens.

We’ve already established that Country X’s need is greater than Country Y. In other words, Country X is desperate to have more wheat, but Country Y would simply like to have more coffee.

So the negotiations and price discovery begin. I won’t get deeply into the political complexities this negotiation could produce, but I will mention a few to put some strategic thinking behind this.

What would happen to Country X if these negotiations took place on their soil? Perhaps Country Y would see that Country X’s people are starving and place a price premium on their wheat.

What would happen if the negotiations took place in Country Y? Would Country X be able to show the people of Country Y just how wonderful coffee really is? And more graphically, what if Country X was unable to convince Country Y to trade or sell or trade some of their wheat?  Would Country X declare war on Country Y to save their people from starving? Certainly there are enough historical examples of precisely this sort of thing in even the most recent context of history: The Ukraine’s current need for Russian oil, Japan’s attack on Pearl Harbor, the list goes on.

Returning to the point at hand however, Comparative Advantage assumes the idea of ceteris paribus (all else equal), and this is important because the ultimate solution, and price point in terms of how many bushels of wheat will be traded for pounds of coffee, can’t be found without first dealing with the basics. So let’s look at an optimum scenario mathematically under ceteris paribus conditions.

Country X Produces Coffee and Wheat at these costs and volumes:

Country X has a specific need for 600 more bushels of wheat, but would like to have 900 bushels. They also need at least 1000 pounds of coffee, but would like to have 1200.

Country Y Produces Coffee and Wheat at these costs and volumes:

Country X has an implied need for 600 more pounds of coffee; implied need because Country Y’s citizens may not know how wonderful coffee is yet. Country Y can get by with only 300 pounds of coffee. They also need at least 800 bushels of wheat, but would like to have 1000.

Country X can supply all 600 pounds of coffee that Country Y would like to have.

If Country Y sells all of their spare inventory they can supply 700 bushels of wheat out of the 600 Country X needs.

Assuming both countries agree to these conditions and full production occurs in each country, let’s rework the tables in the context of this trade.

Country X Trade Production Schedule

Country Y Trade Production Schedule

Notice I’ve added a line to each table indicating the volume of imports for each country at their own respective costs of producing that good. This is very important because it shows the specific line item cost savings incurred by importing goods in trade for other goods. Viewed this way, both Country X and Country Y had a net cost savings. Also notice that Country Y actually made a substantial $3500 profit from the trade.

Let’s take a closer look at country X. If we examine the percentage of efficiency produced by the trade for Country X, the total cost of production went from $4000 to $3400, or a net cost savings of $600, equivalent to 15%.

1-(3400/4000)=.15

By contrast, Country Y was able to buy coffee that’s very expensive for them to produce themselves on the cheap. By trading most of their excess wheat supply, Country Y actually saved $6000 in coffee production. In efficiency terms, this is a net efficiency increase of 340%.

(2500+6000)/ (-3500+6000) = 8500/2500 = 3.4

So what if the conditions aren’t all equal? We’ve already discovered that Country X has a very specific need for food, but Country Y considers coffee to be important, but not inherently necessary.

Let’s assume for a moment that Country Y only wants 300 pounds of coffee from Country X, and is only willing to provide 300 bushels of wheat to Country X in return.

Country X Production Schedule

Country Y Production Schedule

Now we have a problem. Country X doesn’t have all the wheat it needs, and is still short 200 bushels of wheat. Country Y is perfectly satisfied with the 300 pounds of coffee it got from Country X. Country X still had a net efficiency increase, but still doesn’t having enough wheat supply to feed its citizens.

So what should Country X do?

This is where the political economy becomes increasingly important to understand. Here’s a few options Country X might consider to cover their 200 bushel wheat deficit.

1. Country X could trade coffee production capacity for wheat to equalize the combined demand for coffee in both countries, although they might still come up short of wheat, or they might sacrifice too much supply. (The later of which isn’t necessarily bad if one wishes to raise prices and can still maintain a buyer at higher prices while producing enough wheat for themselves.)
2. Country X could trade coffee with a third country.
3. Country X could convince Country Y to sell some of their excess coffee to a third country at a premium.
4. Country X could buy wheat from a third country with their $900 cost savings.
5. What other options can you think of, short of starting a war, or stealing food?

Let’s take this a step further shall we?

Over time, Country Y has grown to enjoy their coffee from Country X. Productive capacity at producing wheat in Country Y  has increased by 30% because its citizens are awake enough to be able to work a full day. Instead of producing 1500 bushels, they’re now producing 1950 bushels in the same period of time.

Because Country X is now well fed, their coffee production has increased 25% from 2000 pounds to 2500 pounds in the same period.

1. Recalculate and find the net productive efficiency of each country assuming that Country X now requires 1000 bushels of wheat, and Country Y requires 700 pounds of coffee.

2. Assume that there has been zero population growth for both countries, but an increase in productive capacity as listed above. What actions could each country take to use up their excess supply and simultaneously reduce their costs of production?

3. Both Country X & Y have been building wooden carts to ship their products back and forth to each other, but they’re running out of lumber. Country Z has a surplus of lumber of 1000 units at a production cost of $5 per cord. Country Z would like to have 800 bushels of wheat, and 500 pounds of coffee. Can it be done? Find the optimum solution in this scenario, assuming Country X is producing 2500 pounds of coffee and Country Y is producing 1950 bushels of wheat. Justify your result.

4. If the three countries couldn’t find a trade solution to Country Z’s problems, what else could Country Z do?