Tuesday, November 4, 2008

The Loony Loonie

Quote of the week:

'I tried to get cash out of the ATM but it said 'Insufficient Cash'. I didn't know if it meant them or me.'- quoted from the Globe and Mail speaking about Banks.

Some previous articles from the IWB have been picked up by the International Business Times. Please click here, drive up traffic and leave some comments.

Commentary of the week:

The Loony Loonie:

As you may have noticed if you went over to the US this last week in order to test whether the overzealous border guards are still keeping us safe by checking whether someone is sneaking in cats across the border, the exchange rate between the Loonie and the Greenback seems to be in a bit of flux. Currency traders don't know if the US$ is going up, down, sideways, into hiding or whether refugee status is about to be granted to the Japanese Yen. Sometimes the world's smartest people believe the CDN$ is worth $0.80US, sometimes $1.45 and sometimes it's worth more than what you can find at the dollar store. So what are we as Canadians subject to this kind of fluctuating standard of life supposed to think about this sad and confusing state of affairs?

Sometimes events such as this prove something, but by the grace of God we live in a theory-free environment here at Ittihad, so we know that events of this past week prove nothing - they just point us in many different directions. First, despite our various governments' assurances to the contrary, things are not fine and dandy and our beloved policy-makers have no clue about how to deal with the crisis or where the next blow-up (yes, this is actually a financial term nowadays) will be. Second, what started in the debt markets has spread to the real economy, to the fictional and now to the fantastic. After all, currency markets are fantastic in the sense that they are the most liquid (more money moves through these than anywhere else), most efficient (more or less instantaneous trades), they never close (yes, currency can be traded 24/7/365.25) and above all they generally enjoy the perception of having currencies backed by governments and thus essentially worth something. Third, we discover a link between resources and the CDN dollar, but a confusing absence of a corresponding link between the US$ and resources (this may not be entirely true, but bear with me for a moment). We thus discover that this link is not as solid and obvious in the short run as we would like for us to be happy about living in a sensible world.

In theory, currencies trade against each other based on supply and demand, meaning if someone from Mongolia wants to buy up lots of CDN oil, gas, maple syrup or beaver pelts (fur is wrong btw), they have to buy CDN dollars by exchanging Togrogs for dollars, driving up the price of dollars and driving down the price of Togrogs. Since Canada has lots of agricultural produce, oil, gas, meat and brains to export, people have enough demand for the dollar. When the price of any of these commodities such as oil, wheat, uranium etc. goes up, people from abroad need to buy more CDN loonies in order to buy the commodities they need and this excess demand drives up the value of the CDN loonie as well. Of course, this works the other way around as well. If the price of oil falls, less CDN dollars are needed by foreigners to pay for the oil, so demand for CD loonies falls and the value of the loonie falls as well. This is the theory anyway, and given what has happened to the exchange rate recently, this is the way things have been explained to us. Canada, it is said, is a resource based economy and as the price of Oil goes, so does the price of the Loonie. Sounds simple, doesn't it?

Perhaps too simple. While it may be true that the correlation between the price of Oil and the CDN Loonie is such that we think they are stalking each other harmoniously, there is something deeper that drives both of them perhaps. Let us use the price of Oil as an example to make this point clearer. Let us say that the world uses X barrels of Oil per day and this demand is somewhat inelastic in the sense that regardless of whether gas is 90 cents or $1.50, driving around Northern Ontario in the fall is still a necessity and un-give-up-able. Let us now ask what the price of oil has been over the last little while given that demand for oil is somewhat constant. Lo and behold, we find that the price of oil has gone from $140 this past summer to around $60 now, but demand has been steady in the sense that there are still as few bicycles on the street as there were over the summer (perhaps even fewer) and we have not discovered any new ocean of Oil under yet another Arab country which has doubled our supply. Why then, according to the theory, is the price of Oil falling?

Well, this is where the theory of course breaks down a bit and all sorts of qualifications have to be added. It seems that it is not just present demand that we have to take into account but the futures markets as well. This means that you and I (actually just you, because my bicycle does not use gas) have been paying for gas at $1.40 for a few months not because there was some present demand, but because there were all sorts of investors who had borrowed money from banks in order to buy futures contracts of oil for speculative purposes. Now that the banks have called back those loans and these investors are realizing once again that prices can move both up and down, this pressure in the oil market is gone and we are seeing Oil drop to $60. It is this cooling of speculative froth that has brought down the price of oil and through its effects on the Loonie, our standards of living as well.

One gets the impression more and more that the stock market is just daily theatre for the masses while the real business of the day gets done in the futures and derivatives markets by people of 'vision'. What is worse is that the ideas being bandied around to solve the issues at hand are being developed by the same visionaries that thought making commodities expensive for the rest of the world in order to make trading profits. Over $700Billion in the US and tens of Billions of CDN tax dollars later, perhaps our short-sightedness in trusting fantastic visions of the future over a little bit of sense now will finally become clearer.

Noteworthy News

Finance News:

1. Wachovia Bank declares a $24B loss for the quarter. This is the bank that financed and has grown along with RJ Reynolds (of Marlboro cigarettes fame) since the 1950's ... read more here

2. 10 Reasons to be Optimistic about the markets ... read more here

3. Some Investment Banking humour ... read more here

4. 5 things to know if you're thinking about Real Estate (not all advice is beyond question of course) ... read more here

5. A good column on Investor Psychology ... read more here

Economic News:

1. The wonders of Globalization. Iceland's financial system is the first to collapse completely, requiring a 'bailout' by the IMF ... read more here

2. Interesting video on the way the Monetary system works (or doesn't really work) ... read more here

3. The best picture to describe the US economy I have seen yet on this page (good article too btw) ... read more here

4. The investment views of one of the finest investors in Canada (who has also lost lots of money) ... read more here

Islamic / Middle East / Emerging Markets:

1. Slowdown in Persian Gulf has grave implications for non-oil exporting Arab countries ... read more here

Interesting but not all Finance:

1. Is sentence length is important if you are running for President in the US? ... read more here

2. Margaret Atwood on the Debt Crisis and how fairness should be the cornerstone of finance. I wonder if someone pointed her to the usury laws of Abrahamic faiths ... read more here

3. Very interesting article on the politics of being Muslim in the US during the election ... read more here

4. Rotterdam gets a Muslim mayor ... read more here

5. Personal stories of some great risks ever taken by people in business for themselves ... read more here

6. A nice story about the biggest mosque in Germany ... read more here

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