Actual progress in exchange rate economics

In this paper, we show that there is substantial comovement between prices of primary commodities such as oil, aluminum, maize, or copper and real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar. We therefore explicitly consider the production of commodities in a two-country model of trade with productivity shocks and shocks to the supplies of commodities. We calibrate the model so as to reproduce the volatility and persistence of primary commodity prices and show that it delivers equilibrium real exchange rates that are as volatile and persistent as in the data. The model rationalizes an empirical strategy to identify the fraction of the variance of real exchange rates that can be accounted for by the underlying shocks, even if those are not observable. We use this strategy to argue that shocks that move primary commodity prices account for a large fraction of the volatility of real exchange rates in the data. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated final goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.

That is from Joao Ayres, Constantino Hevia, and  Juan Pablo Nicolini, via Ilya Novak.


All very well and good but Stockman (1988, not Dave but the deceased economist) showed real exchange rates and nominal rates don't matter. Part of that maybe was noise? Trading for big economies is not a big deal, arguably even for Germany. I use the Stockman paper as evidence money is neutral (big swings in exchange rates don't matter). All those economic models that depend on tradable goods to bring money supply and what not into balance are therefore bunk. The Spanish Empire ran a trade surplus for years (Ag, Au, New World) and they went bust. The USA has a trade deficit for years and...they too will go bust? Trade = {0}.

Bonus trivia: the Black-Sholes equation assumes no drift in prices. Counter-intuitive a bit but makes sense (for any given option there's an equal money that one side will win the bet and the other will lose in a finite amount of time, so on balance a fairly priced option has no 'drift' or positive bias; compare to the overall stock market which does have a positive bias upwards, due to the fact there's no expiration date on the stock market (Gambler's Ruin paradox). Yes I do quant modeling for fun, working on something now.

Ray Lopez is Tyrone

Commodities are finite, the more you dig it up the less you have. It is Brownian motion with a drift term. Hence the safe rate is not constant and one needs a more exotic options model.

Peak oil? Limited gold? Only so much copper?

In the 1900's, the concern was that there would not be enough space or food for the horses.

What the commodity finites ignore is the change in technology...both for extraction and use.

Here's a link which traces commodity prices and technology change:

What isn't covered by changes in technology is commodity cartels.

If this is meaningfully true, can't it be used to make a trading profit?

I saw this research before and took a look at oil and dollar value.

Yes indeed, we had an oil shock in 2008.

Oil jumped, the dollar plunged, recession hit. The oil plunged, the dollar jumped, and the recession stopped. Pretty much like the article says.

Things are a bit different now. We picked up fracking.

I saw that at the time, too.

I was wondering. Did the high price of gasoline result in Merced, CA-to-San Francisco Bay Area, CA commuter crowd to desist from buying more and larger McMansions and ultimately default on their subprime mortgages resulting in the home-price crash?

Things are different now. America is energy-independent (YAY!). And, they (the Fed, FHLMC/FNMA, Wall Street) aren't advancing $2 trillion in subprime RE loans or repackaging them into complicated mortgage-backed investment vehicles.

Independence is a joke. What you need is ineffective cartels and worldwide non-opec expansion.

Why do we continue to subsidize the oil industry when we are exporting oil and natural gas.

Do we do this to help our foreign customers?

Make them pay for the wall by taxing exported oil and natural gas to make up for the subsidy.

Explain the phrase in 100 words or less ""subsidize the oil industry."

Is this how a Ray Dalio can generate enormous gains by trading in currencies, even as his trading has the salutary effect of maintaining equilibrium (i.e., stability, or less volatility)? Dalio defends such trading as providing a more efficient allocation of a scarce resource, namely capital. Equilibrium (stability) would do that.

When I was a young cuck, I used to ponder how commodity prices affected real exchange rates. Later on I grew up and out of economics. Now I am cuckfree and I no longer think such thoughts.

Regarding to the options pricing comment: Is the thing you've been smoking now legal in your state? I want some of that! Until I can get a puff of it, I still think that the short-term CAPM expected return of an option is proportional to it's short-term beta, not equal to risk free rate.

In theory, trading exchange rates should be as close to a zero sum game as you an find.

Yet virtually every major trading houses and multinational banks maintain large scale exchange desks that pay million dollar bonuses
and consider the operation a profit center.

These two things seem to be contradictory.

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