Hedging Foreign Exchange Risks
The exchange rate of the Macedonian Denar against the major hard currencies of the world has remained stable in the last few years. Because of the IMF restrictions, the local Narodna (Central) Bank does not print money and there are no physical Denars in the economy and in the local banks. Thus, even if people want to buy Foreign Exchange in the black market, or directly from the banks - they do not have the Denars to do it with. The total amount of Denars (M1, in professional financing lingo) in the economy is around 200,000,000 USD, according to official figures. This translates into 100 USD per capita. Thus, even if each and every citizen of Macedonia were to decide to convert ALL their Denars to Deutsch Marks - they would still be able to buy only 150 DM each, on average. These tiny amounts are not sufficient to raise the rate at which DMs are exchanged for Denars (=the price of DMs in Denars). But will this situation last forever? According to economic theory scarcity raises the price of the scarce commodity. If Denars are rare - their price will remain high in DM terms, i.e. they will not be devalued against the stronger currency. The longer the Central Bank does not print Denars - the longer the exchange rate will be preserved. But a strong currency (the Denar, in this case) is not always a positive thing. The Denar is not strong because Macedonia is rich. The country is in a problematic economic situation. The banking system is perilous and unstable. The reserves of foreign exchange are minimal - less than 30 million USD. The currency is stable because of externally imposed constraints and an artificial manipulation of the money supply. Moreover, a strong currency makes goods produced in Macedonia relatively expensive in outside, export markets. Thus, it is difficult for Macedonian growers and manufacturers to export. When they sell their goods in Germany, they get DM for them and when they convert these receipts into Denars - they get less then they should have if the Denar reflected the true relative strengths of the two economies: the German one and the Macedonian one. They pay expenses (e.g.: salaries to their workers, rent, utilities) in Denars. These expenses grow all the time as true inflation grows (as opposed to the official rate of inflation which is suspiciously low) - but they keep getting the same amount of Denars for their produce and products when they convert the DMs which they got for them. On the other hand, imports to Macedonia become relatively cheaper: it takes less Denars to buy goods in DM in Germany, for instance. Thus, the end result is a growing preference for imports and a decline in exports. In the long term, this increases unemployment. Export is the biggest driving force in creating jobs in modern economies. In its absence, economies stagnate and dwindle and people lose their jobs. But an unrealistic exchange rate has at least two additional adverse effects: One - as a rule, various sectors of the economy borrow money to survive and to expand. If they expect the local currency to be devalued - they will refrain from taking long term credits denominated in hard currencies. They will prefer credits in local currency or short term credits in hard currencies. They will be afraid of a sudden, massive devaluation (such as the one which happened in Mexico overnight). Their lenders will also be afraid to lend them money, because these lenders cannot be sure that the borrowers will have the necessary additional Denars to pay back the credits in case of such a devaluation. Naturally, a devaluation increases the amounts of Denars needed to pay back a loan in foreign currency. This is bad from both the macro-economic vantage point (that of the economy as a whole) - and from the micro-economic point of view (that of the single firm). From the micro-economic point of view short term credits have to be returned long before the businesses which borrowed them have matured to the point of being able to pay them back. These short term obligations burden them, alter their financial statements for the worse and sometimes put their very viability at risk. From the macro-economic point of view, it is always better to have longer debt maturities with less to pay every year. The longer the credits a country (single firms are part of a country) has to pay back - the better its credit standing with the financial community. Another aspect: foreign credits are a competition to credits provided by the local banking system. If firms and individuals do not take credits from the outside because they fear a devaluation - they help to create a monopoly of the local banks. Monopolies have a way of fixing the highest possible prices (=interest rates) for their merchandise (=the money they lend). Access to foreign credits reduces domestic interest rates through competition with the local credit providers (=banks). It would be easy to conclude, therefore, that it is an important interest of a country to be open to foreign financial markets and to provide its firms and citizens with access to sources of foreign credits. One important way of encouraging people (and firms are made of people) to do things - is to allay their fears. If people fear devaluation - a responsible government can never promise not to devalue its currency. Devaluation is a very important policy tool. But the government can INSURE against a devaluation. In many countries of the West, one can buy and sell insurance contracts called forwards. They promise the buyer a given rate of exchange in a given date. But many countries do not have access to these highly sophisticated markets. Not all the currencies can be insured in these markets. The Macedonian Denar, for instance, is not freely convertible, because it is not liquid: there are not enough Denars to respond to the needs of a free marketplace. So, it cannot be insured using these contracts. These less privileged countries establish special agencies which provide (mainly export) firms with insurance against changes in the exchange rates in a prescribed period of time. Let us examine an example: The firm MAK buys combines and tractors from Germany. It has to pay in DMs. An international development bank offered to MAK a loan to be paid back in 7 years time in DM. Today, MAK would be so afraid of devaluation, that it would rather pay the supplier of the equipment as soon as it has cash. This creates cash flow problems at MAK: salaries are not paid on time, raw materials cannot be bought, production stops, MAK loses its traditional markets - and all in order to avoid the risks of devaluation. But - what if the right government agency existed? If governmental insurance against devaluation existed - MAK would surely take the 7 year loan. It would take, let's say, 10 million DM. MAK would apply to the governmental agency with its business. It would pay the government agency a yearly insurance fee of 2.5% of the remaining balances of the loan (as it is amortized and reduced with each monthly payment). This would be considered a proper financing expenditure and the firm will be allowed to deduct it from its taxable income. The government will provide MAK with an insurance policy. An exchange rate (let us say, 30 Denars to the DM) will be stated in the policy. If - at the time that MAK had to make a payment - the rate has gone above 30 Denars to the DM - the government will pay the difference to MAK in DM. This will enable MAK to meet its obligations to its creditors. MAK will be able to cancel this insurance at any time. If, for instance, it suddenly signs a major contract with a German buyer of its products - it will have income in DM which it will be able to use to pay the loan back. Then, the government insurance will no longer be needed. This very simple government assistance will have the following effects: - It will encourage firms to obtain foreign credits.
- It will create competition to the local banks, reduce interest rates and encourage a wider and better range of services offered to the public.
- It will encourage foreign financial institutions to give loans to local firms once the risk of re-payment problems due to a devaluation is minimised.
- It will place Macedonia in the ranks of the more developed and export oriented countries of the world.
- It will facilitate activities with longer term credits (such as modernization of plants for which longer terms of payments are required).
As time goes by, the private sector may step in and supply its own insurance against devaluation . Insurance firms the world over do it - why not in Macedonia which needs it more than many other countries? About The Author Sam Vaknin is the author of "Malignant Self Love - Narcissism Revisited" and "After the Rain - How the West Lost the East". He is a columnist in "Central Europe Review", United Press International (UPI) and ebookweb.org and the editor of mental health and Central East Europe categories in The Open Directory, Suite101 and searcheurope.com. Until recently, he served as the Economic Advisor to the Government of Macedonia. His web site: http://samvak.tripod.com |
Other Trading System Articles
FOREX Online Trading - An Introduction The Foreign Exchange Market (better known as the FOREX or FX market) as we know it today was established in 1971, following the abolishment of fixed currency exchanges. Operating 24 hours a day, 5 days a week, the daily currency trades on the FOREX market are worth in the region of $1.9 trillion US dollars making it the world's largest market a ...Wall Street to Main Street: News, Views and Commentary: April 12, 2006 Political FrontOn Tuesday Iranian President Mahmoud Ahmadinejad said that Iran has joined the club of nuclear countries by successfully enriching uranium for the first time. Iran claims that their venture into the nuclear arena is purely a peaceful energy program. Now if they expect the world to believe that their intentions are noble the ...General Guides for FOREX Trading Newbie Being new to FOREX trading? Don’t worry, getting started in FOREX trading is easy and you can always test your skills first in a demo account before you go ‘live’ with real money. To get started in FOREX trading, we have to get to know what FOREX is. For the inexperienced, FOREX trading involves buying and selling the different currencies of the ...Planning for the least Playback Time of Surveillance Video When you prepare to install a video surveillance camera system for protection and security of your home, you should not neglect to plan in advance for the time needed to review the recorded images.Please be advised that your choices of Video-surveillance systems, will determine, among other things, the amount of footage of video recording ...Forex Trading Education: Things You Should Know About Forex Trading How difficult is it to make money trading the Forex market? How much time does it take to actually be able to make a living trading the Forex market? These and other important aspects of trading are to be discussed in this article.Trading the Forex market has many benefits over other financial markets, among the most important are: superi ...Developing the "Holy Grail" Trading System Before I get myself into trouble, let me point out that there is no "Holy Grail" trading system in the world - not yet anyway. If there is, please let me know. I don't mind paying a thousand bucks for it. However, a trading system close to the "Holy Grail" is indeed possible and I'll show you how to develop it.But before we come to that, ...Ever Been To A Pow Wow? Selling today has, in many cases, become like a giant shell game, or what I refer to as the Big Pow Wow. For those of you who haven't got a clue as to what I am talking about, let me explain. Years ago, when the white man invaded the Native American's homeland, they would often bring gifts. These gift exchanges were accomplished with a variety o ...Portuguese Market General economic indexes Portuguese market:Located in the South-Western Europe Portugal serves as a gateway to Europe. Its GDP equals to 188,700,000,000 USD, GDP per capita equals 17,900 USD; inflation rate equals to 4.4 percent, unemployment rate equals to 4.4 percent, Portuguese external debt equals to 13,100,000,000 USD . Portugal is a ...Fibonacci Retracement Trading - Take Advantage Fibonacci, Actually named Leonardo of Pisa, was born in Pisa, Italy about 1175 A.D.. Today, he is recognized as the greatest European mathematian of the middle ages. Fibonacci is credited with introducing the Arabic-Hindu numeral system to Europe. He also introduced the decimal system. Both became the basis of mathematics we use today. Enough ba ...50 Day SMA: A Simple Method for Monitoring the Trend The price chart offers us the gift of hindsight; we can all see where the price has been so we can all see overall trend. However this gift of hindsight can be a misleading one. It is all too easy to recognise what you would have done now that you have seen where the price has ended up. If hindsight is somewhat misleading then foresight would be ...Environmental Issue: Solar Power for One Million Roofs The U.S. Department of Energy's (DOE) Million Solar Roofs Initiative is an ambitious project, but it's important to America in terms of generating and conserving energy. The Initiative proposes to install solar energy systems in one million U.S. buildings by the year 2010.The project was first announced on June 26, 1997, by President Bill ...Why Choose Forex Trading Over Stocks Trading Forex trading holds significant differences to stocks trading. Understanding these differences will aid a trader in deciding the right market to enter. Forex trading itself has several advantages over stocks trading and is ideal for the beginner and individual small investors.1. Low Transaction Costs for Forex Trading. There are no h ...Trading Software Trading is a risky business, but if carried out with care it can result in huge profits. It involves getting a firm hold in the market, either short or long term. Realizing the importance of trading, trading software programs have been introduced to the public to offer a variety of trading tools to help make proper buying or selling decisions. ...Revealed - Million Dollar Forex Investing Mistakes Anytime that you are investing in the Forex market, you are going into the Market blind. You don’t know what point of the investing trend you are entering in at. You might be investing in a Forex stock just before the trend changes. Smart investing means you need to protect your trading float and set up a stop loss. This needs to be done before ...Online Futures Trading – How to Trade Futures for a Living Online futures trading is one of the few ways traders can start with small stakes, and build real wealth quickly - and the opportunity is open to anyone.Everything you need to know about futures trading can be self-taught - using the Internet. As with all ventures in life, there’s a right way to do it.Many traders fail because they ...How to Rate Your Favorite Uranium Company Many investors invested in the Great Uranium Bull Market with little rationale behind their speculation. Through the robust rallies of the past two years, it was easy to play the momentum of a newsletter writer’s recommendation. Quite a few did so, often employing the ‘greater fool strategy’ and hoping the last and dumbest investor would provide ...5 Kick-Arse Tactics To Seize Favorable Probabilities at Forex As you ponder how to balance your forex portfolio, it is important to map out sure-fire strategies beforehand.With your plan, you optimize your reward with respect to the expected risk, and tweak probabilities to your favor. Forex strategies must be disciplined and limit risk; simultaneously, it positions you at the most favorable advant ...Aloe - It Is Used Internally To Combat Poor Appetite, Asthma Aloe Vera information and how it is used as a herb in alternative herbal treatments to treat ailments and problems such as healing wounds, for skin rejuvenation, acting as a laxative and reducing skin irritation and relieving sun burn.Although we believe in the therapeutic and healing properties of herbs, care must be taken in the use the ...How to Evolve a Financial Success System More often than not, people associate success with money and wealth. While that is a lopsided view of success, it is true that success often brings with it financial rewards; it is also true that many people who aspire to success are thinking of the financial rewards that will follow when they succeed. But what if your idea of success is purely ...The Gaian Paradigm Part 2 Part 2 The Implication of the Gaian Paradigm to Social InstitutionsThe new Paradigm is a scientific hypothesis which explains many phenomena in cosmic evolution. But it is more than that. It suggest a new worldview or mindset by which humans can examine current phenomena with respect to their long range future. Futurists are no long ...
| 