« Quantos ....do they improve price discovery? |
Main
| Derivatives in Public Finance | Oil prices in India »
November 20, 2008
Quick fixes won't work in the real economy: Implicit Dollarisation and its impact on national incomes and global trade in volatile times
Most of the invoicing of international trade is done in USD (Pl note technically the invoicing currency maybe be distinct from the currency in which the payment is made).
Last year the global trade was USD 13.6 trillion approximately.
And Global GDP in the same period was USD 54.3 trillion.
With an increasing Global trade/Gloabal GDP ratio, pricing of tradeable goods and services is increasingly happening in US$ implicitly if not explicitly. The moment the domestic pricing (in a country whose currency is not the USD) moves away from US$ price in the international market, there is likely to be an arbitrage in that tradeable good/service.
For example, if I can buy copper(of a certain grade) for say USD 2,500 per tonne while the internatonal price of the same grade of copper is USD 3,500 per tonne; I could make some riskless profit if the difference is higher than the transaction costs(freight,etc).
What does this mean for price risk managment in corporates outside the US?
How does such a corporate entity manage its implicit currency risk(say in the above example, a liquid OTC contract for copper in the domestic currency is not available, neither is there a liquid copper futures contract in the domestic currency) for its purchases and sales in the domestic market.
I think the solution is simple if the correlation of US$ equivalent prices and US$ price in international market is very high.
Often significant correlation exists,but it is a lot less than perfect.
This low appreciation and a lack of management(where posssible) of implicit currency risks is going to increasingly hamper prospects of global trade in the future.Already we know from media reports that the World Bank expects a contraction in global trade :
In closed-door talks, leaders also discussed ways for nations to boost government spending to counter a global slowdown that could lead trade to contract next year for the first time since 1982, said World Bank President Robert Zoellick.
(Source: 8th Nov '08 Washington Post)
While the adverse impact on trade would be partly because of credit crunch( only US$ 25 bn as per an arguably over-optimistic(my words) market estimate mentioned by WTO )the problem might infact be much larger because of lower churning of trade credit and super-high volatility in the currency market (the good i.e. non-toxic linear derivatives called a forward contract can only postpone the problem of volatility, and the good non-toxic derivative called a plain vanilla option is extremely expensive).
PROBLEM STATEMENT : Implicit dollarisation, or implicit euroisation or any other implict foreign currency--isation is almost inevitable for other countries considering the long term trend of growth in international trade. The accompanying implicit currency risk is also a reality which will only grow in the long term.
OBSERVATION: Until volatility in currency market subsides, not only international trade, but also national incomes will suffer from low growth/contraction.And unfortunately, it might not be possible to accelerate stabilisation(reduction in volatility) in the currency markets since acceleration to an unknown level would cause the volatility to spike! Quick fix solutions could be counter-productive even if they were available
WHAT DO YOU THINK?
Posted by amgodbole at November 20, 2008 02:14 PM
Dolarisation? Crude oil has been substantially more stable against the Euro than in US$.
I am not sure that your premisse on invoicing in US$ will stand up to inspection.
Mark van Huijstee
Posted by: Mark van Huijstee at December 14, 2008 03:28 PM
Hi Mark,
Thanks for sharing your thoughts.
Towards the end of my weblog I did mention:
"......Implicit dollarisation, or implicit euroisation or any other implict foreign currency--isation is almost inevitable for other countries considering the long term trend of growth in international trade. The accompanying implicit currency risk is also a reality which will only grow in the long term.
.............."
The point I am trying to make is that due to increasing global trade(atleast that is the long term trend) there is an implicit foreign currency risk if a particular commodity/service is priced in a foreign currency in global markets.
Thus, even if oil were priced in euros, in India we there would still be an INR/EUR implicit risk even on the crude oil extracted domestically! This would also be relevant for any other country outside the eurozone.
Can you pl share your research(or reading) on oil price being more stable in euros? Does this hold true for tick-by-tick data (not a possibly over-simplified analysis of daily price of oil in euros)? Or have you noticed this for any other commodity/service?
Posted by: Aniruddha Godbole at December 18, 2008 11:11 AM
Post a comment
