The Currency Exchange Markets
I have not tested this! This is merely a theoretical exercise, whose applicability to the economic
world is completely questionable.
Currency exchange markets [this does not include legislated equivalences such as the Hong Kong
dollar relative to the U.S. dollar] have an unusual trait: assuming "sufficient liquidity", they are
always at "near real-time" equilbrium. Assuming there is a reasonable supply of currency,
"sufficient liquidity" is enforced by computers as currency traders; the computers will try to
rectify all triangle-trades. [For band-type regimes, this heuristically should apply "near the
middle" of the band.]
This is a qualitative difference from the 1930's Great Depression: the trading triangles are now
"rigid" rather than "floppy". I haven't thought out whether this should amplify or mitigate the
However, considering the provocation to violence in Indonesia (ethnic Moslem vs. ethnic
Chinese, ethnic Christian, or police stations; particularly since Ramadan 1998) and South Korea
(labor unions directly clashing with military and/or police; particularly since January 1999), I
would speculate that the net effect of "rigidizing" the currency triangles is to amplify the effects.
Those of you who actually know the technical terminology, please excuse the informal way I
write this up. My background is very limited. (I'm a mathematician and programmer, not an
economist!) If my Lord Jesus Christ has granted me an accurate self-knowledge of my
knowledge, I should have near-total recall for the fundamentals covered in the following courses
at K-State: Intro to Microeconomics [F89], Intro to Macroeconomics[S90], or Intermediate
Microeconomics[F90]. I should fade out very quickly after that.
I will define intercurrency trade as the export of a good or service from one currency area to
another. There are two cases: price in buyer's currency, or price in supplier's currency. In any
case, the buyer's currency must be different than the currency the supplier needs for its bank
accounts and ultimate bookkeeping.
Now, let's apply this to the infamous Japan trade surplus with the U.S.A. and the corresponding
(exact-negative) trade deficit of the U.S.A. with Japan. This has two components:
- If the price is in the buyer's currency, this creates an automatic supply of buyer's currency.
- If the price is in the seller's currency, this creates an automatic demand for the seller's
currency. [This is often illegal; for instance, it is illegal to price goods in U.S. dollars in
Brazil. At least, this was reported in CNN Custom shortly after Brazil's real devaluation.]
We assume that both goods and services from Japan, in the U.S.A., are priced in U.S. dollars.
We also assume that both goods and services, from the U.S.A., in Japan, are priced in Japanese
- Japanese exports to the U.S.A. [Automatic supply of U.S. dollars]
- U.S.A. exports to Japan [Automatic supply of Japanese yen]
Let's assume that the BoJ gets its target rate (as of somewhen in May 1999) of 120 yen/U.S.
dollar, and that this is relatively stable. Let's furthermore fantasize that the trade surplus with the
U.S. is, say, 1.0 trillion yen/month. Supposing the exchanges are open 24 hours/day, let's pretend
that we're in a 31-day month, so the trade surplus for a given day is about 48 billion yen. [Both
"trillion" and "billion" are American: 12 and 9 zeros, respectively.] [We will also do a what-if the
trade surplus was 1.5 trillion yen/month. These figures are from the March 1999 trade surplus
figures reported in May 1999. The what-if has a trade surplus of about 72 billion yen for the day
Now, realize that this figure is resulting from:
But the exchange rate is resulting from
- "U.S. sales in Japanese yen"-["Japanese sales in U.S. dollars"*"Exchange rate"]=48 billion yen
College Algebra exercises: VERIFY THESE CLAIMS!
- ["U.S. sales in Japanese yen"+"other sources of yen"]/["Japanese sales in U.S. dollars"+"other
sources of U.S. dollars"]=120 yen/dollar="Exchange rate"
I pulled my example trade surplus numbers from a report in the May section of the Crash page.
- If there were no other sources of either yen or U.S. dollars, then the left-hand-side would be
zero, which is not allowed.
- If we substitute in the right-hand side of the exchange rate, we get
- "U.S. sales in Japanese yen"-["Japanese sales in U.S. dollars"*["U.S. sales in Japanese
yen"+"other sources of yen"]/["Japanese sales in U.S. dollars"+"other sources of U.S.
dollars"]]=48 billion yen, which rewrites as
- "U.S. sales in Japanese yen"*["Japanese sales in U.S. dollars"+"other sources of U.S.
dollars"]-["Japanese sales in U.S. dollars"*["U.S. sales in Japanese yen"+"other sources
of yen"]]=(48 billion yen)* ["Japanese sales in U.S. dollars"+"other sources of U.S.
- [The formal units of the above rewrite are yen*dollar, which is (as far as I know)
economically meaningless.] Fantasize that in the revised projection (72 billion yen),
that the only variable is (Japanese sales in U.S. dollars). This obviously tends to
strengthen the yen. Note that Le Chatlier's Principle (from chemistry) probably applies
here, in which case the actual shift will be in the same direction, but less than, the
directly computed shift. EXERCISE: compute the interval within which the above
shift must fall.
I will define an intercurrency loan as a loan that must be paid back in a different currency than
the local currency. These were instrumental in starting the Crash in June/July 1997.
Observe that when an intercurrency loan is disbursed, it creates an automatic supply of the
lender's currency (which generally is diffused over days or months).
The problem is when an intercurrency loan is repaid. Intercurrency loan repayments create an
automatic demand for the lender's currency. [Now, we see why it is often illegal to price imports
in the exporter's currency...] If automatic demand for the lender's currency exceeds automatic
supply (from the trade surplus and other sources), there is a risk that the borrower's currency will
have a 'desperation boost' in supply. This 'desperation boost', if not matched by a supply boost in
the lender's currency, will result in a shortfall of actual demand of the lender's currency relative to
automatic demand. Mass loan defaults follow.
Malaysia had the unusual situation that a major Malaysian oil company did its accounting in U.S.
dollars. This allowed Malaysia to defend its ringgit with the oil company's income stream, rather
than Malaysia's central bank reserves. This was critical in Malaysia's preliminary defense against
the Crash, buying time for Marathir to construct the Malaysian Firewall.
This is obviously a key factor in the collapse of the Thai baht, the Indonesian rupiah, and the
South Korean won. At the start of each of these currency collapses, the percentage of
intercurrency [international] loans due in six months, out of the total, was 56%-57%. The
Phillipines, whose currency did not collapse, but did waver, had a maximum percentage of
intercurrency loans due in six months of 55%. Apparently, 54% did not cause symptoms.
Note that none of the four countries, above, is openly documented as having circumstances like
Malaysia's. Also note that we seem to be dealing with a "threshold effect"; qualitatively, the cliff
is somewhere between 54% and 56%, and the edge is near 55%.
George Fisher has pointed out to me that there is a historical analogy of the British trading
houses [1600's?] to the current situation. "... so, there is nothing new under the sun." [Summary
of Ecclesiastes 1:1..11, and the last part of Ecclesiastes 1:9, NASB]
While I do not yet [May 25, 1999] see a potential set of circumstances that could lead to mass
bank runs, etc. in the U.S.A. yet [this did happen in the Great Depression], I am seriously
concerned about any kind of implausible (but possible) circumstances that could disrupt the
Why do I go into all this? Because a serious banking system disruption in any area of the
U.S.A., from whatever improbable and/or implausible direction, is a direct threat to the survival
of everyone in the area. (I'm talking about not being able to take a trip from Kansas City to
Topeka to shop.) This is extreme, implausible -- and has very serious consequences. It definitely
would invoke a "state of emergency".
- In the U.S., collectively, we do not have reasonable reserves of food. I have heard (without
reasonable documentation) that U.S. supermarkets are planned with a turnover time of 3 days
on basic staples. Certainly, the shelves at Walmart in Paola, KS can get very bare on
Thursdays before restocking.
- I have also heard (with reasonable documentation) that only 1%-2% of the U.S.A.'s money
supply is in cash.
- In 1981, it was estimated on TV that a 7.0 earthquake in the Los Angeles area would "disrupt"
the U.S.A.'s banking system in 1 day (presumably by paralyzing a few hundred thousand
checks?). This was before the advent of ATMs and debit cards (the Apple II was released in
1979!), or electronic funds transfer. Now, the disruption time could be mere hours. Or
minutes. (How long does an EFT bank run take to shut down a bank? If anyone reading this
knows about a well-documented account, please email references).
- Also, consider the major icestorm that leveled power lines south of Montreal. (Confirmation
requested: January 1998 or January 1999?). The Canadian armed forces were called in on the
eighth day without power -- in part, because in Montreal the food was about to run out. It
took two months to restore power south of Montreal, and at least two weeks (again,
confirmation?) to restore power in Montreal.
- I seriously advise against taking any sort of publicly visible radical preparation for any
disaster -- it makes you a highly visible crime target during such an event, which is
counterproductive. I do think that subtle changes in routine, applied for months or years, that
are applicable to many different implausible disasters, are reasonable.
- In the U.S.A., the FEMA-recommended resources are definitely reasonable. The
measures listed at Noah's Ark are closely related to the FEMA measures.
Opinions, comments, criticism, etc.? Let me know about it.
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