Résumé of a legendary engineer...!!

Sir Mokshagundam Visveswaraiah

Educational QualificationS
	1879–1881                                                                                                 Madras University Bachelor of Arts
	1881-1885                                                                                     College of Engineering, Pune     Bachelor of Engineering (Civil)
Work experience
	·         Engineer at Public Works Department (PWD) in Mumbai ·          Implemented an extremely intricate system of irrigation in the Deccan area ·         Designed and patented a system of automatic weir water floodgates that were first installed in 1903 at the Khadakvasla Reservoir near Pune ·                  Implemented similar system at the Tigra Dam in Gwalior and the Krishnaraja Sagara (KRS) Dam in Mandya/ Mysore,Karnataka ·                  Designed and implemented a flood protection system for the city of Hyderabad ·                  Developed and implemented a system to protect Visakhapatnam port from sea erosion ·                  Supervised the construction of the KRS Dam across the Cauvery River from concept to inauguration ·                   Responsible for the founding of, (under the Patronage of Mysore Government), the Mysore Soap Factory, the Parasitoide Laboratory, the Mysore Iron & Steel Works (now known as Visvesvaraya Iron and Steel Limited) in Bhadravathi, the Sri Jayachamarajendra Polytechnic Institute, the Bangalore Agricultural University, the State Bank of Mysore, The Century Club, Mysore Chambers of Commerce  ·                  Worked as Diwan of Mysore for 7 years ·                   Instrumental in the founding of the Government Engineering College at Bangalore in 1917, one of the first engineering institutes in India ·                  Commissioned several new railway lines in Mysore states
achievements and awards
	·         Awarded Bharat Ratna by the government of India - India's highest honour in 1955 ·         Appointed as a Companion of the Order of the Indian Empire (CIE) in 1911 ·          Knighted as a Knight Commander of the Order of the Indian Empire (KCIE) by the British in 1915 ·                   Honorary membership of the International Institution of Civil Engineers ·                  Fellowship of Indian Institute of Science (IISc), Bangalore ·                   Awarded several honorary doctoral degrees likeD.Sc., LL.D., D.Litt. from eight universities in India ·                  Awarded honorary Membership of London Institution of Civil Engineers for an unbroken 50 years ·                   College of Engineering, Pune, his alma mater, has erected a statue in his honor ·                  The Visvesvaraya Industrial and Technological Museum, a museum in Bangalore is named in his honor

PPP, this and that

When it comes to exchange rates, we have one, spot exchange rate and two, forward exchange rate. 

It would be obvious that forward exchange rates are used to hedge the risk arising from foreign exchange rate fluctuations.

Hedging to safe guard from exchange rate risks can be done in three ways . As told above, forward market is one. The rest are Money markets and Options markets.

Suppose you are a US citizen dealing with a british company. Well, the british company has to pay you 10 million british pounds after one year. Obviously, there is a risk involved. Because, after one year, you may get less, equal or more dollars per pound due to fluctuations in exchange rate.

1. Better you fix the future rate (called forward rate) to be paid after an year. 

2. You take pound loan, convert and invest in dollars and repay in pounds (money market hedging)

3. Do similar thing as above, but use Option.(Options gives right to buy or sell but not obligation)

Let us see about how japanese wives made millions by Peso trade in some other post

Cross exchange rate helps in finding exchange rates of those currencies which are not commonly traded. 

Example, E(chinese yuan/malaysian ringgit) = E(Chinese yuan/ $) x E($/Malaysian ringgit) 

It is imp to note that cross exchange rate sometimes gives rise to arbitrage opportunities, which however are short lived because of shrewd arbitrageurs waiting for such opportunities. 

Covered interest parity(CIP) and Uncovered Interest Parity (UIP)

Chetan says

CIP refers to situation when the exchange rate risk (henceforth called risk) is hedged by trading in forward market that we have discussed earlier

UIP is when no hedging is done to mitigate the risk

Let us suppose, you want to invest 1$ in US. Let i$ be the interest rate in US. So after one year, you will get (1+i$) dollars.

Now, in another case, if you want invest this 1$ in europe (say) where interest rate is iE. You will first convert it into Euro and invest for an year for which you will get interest. This euro sum after an year will have to be converted in to dollars for your consumption. 

One of the key cornerstone in international macro economics at this point of time, as Chetan says, is that both returns (either you invest in US itself or you convert your dollars into Euros, invest and then convert back to dollars) are equal. This is because, if they are unequal, there is arbitrage opportunity which will be exploited soon and hence short lived. 

Thus, (i+i$) = (1/E($/Euro))*(1+iE) x F ($/Euro) .................. In CIP------------- (1)

This F($/Euro) is the forward rate that you use to hedge the exchange rate risk.

Similarily , we have  (i+i$) = (1/E($/Euro))*(1+iE) x Ee($/Euro)............. In UIP---------(2)

This Ee($/Euro) is the expected future spot market rate.

It follows from (1) and (2) that ... F($/Euro) = Ee($/Euro)

This shows that forward exchange rate is a good indicator of expected future spot market rate. If they are not equal at any point of time, there is an arbitrage opportunity.

Broadly and intuitionally......... Domestic interest rate = Foreign interest rate + Expected depreciation of domestic currency.

It is interesting to note that, there are huge capital inflows into china. One of the major reasons is because its currency is highly undervalued and investors expect it to rise in the future. On contrary note, we frequently hear news that capital has gone out of India because its currency is valued high and is expected fall in the future. ( To 100 INR??!! I wonder :) )

It is surprising to know that it is estimated that all prices converge to a single price in the long run. This is called Law of One Price (LOOP) . And the speed of convergence is about 15% per annum. Note that we are talking about a single individual good here. However, if this logic is extended to a BASKET of goods, it is called Purchasing Power Parity (popularly pronounced PPP ). And this is in absence of transaction frictions (perfect world.. ha ha ..!!) and perfectly free capital flows exist between countries.

So, in our relative prices formula that we discussed in other post, if LOOP is to hold good, relative prices equal to Q(E/US) = 1 (since all prices converge to the same price)

All this is fine. HOW DO YOU FIND EXCHANGE RATE ?

PPP is simply LOOP extended to basket of goods. Therefore if PPP (absolute) is to hold good,

Q(E/US) = 1 => E($/Euro) x Prices in Europe = Prices in US

So, here we are....!!! Exchange rate = Prices in US/ Prices in Europe . It is simply ratio of prices.

This PPP exchange rate is good estimation in the long run. Why?!!!

This is because PPP is based on LOOP, LOOP is based on Price convergence (which essentially means transportation costs and trade barriers slowly vanish) and this price convergence happens ONLY IN THE LONG RUN. 

In the above calculation we have used absolute price levels. However, if we use Change of price levels instead of absolute price levels, we arrive at something called Relative PPP. 

Mathematically Relative Change in Exchange rate at any given time between two countries  = Inflation differential between those countries.

Fore example, suppose inflation in US is 10% and in Europe is 9%. Now exchange rate between US and Europe changes at 10%-9% = 1%. 

The Big Mac Index : Got to see The Economist for more info on this index.

India, China and Forex Game

Chetan Subramaniam is a god level professor at IIM B. With his phenomenal passion towards macroeconomics, he takes you by surprise. He gives simple examples and  makes you think about the complexity of several nation level economic problems. And I just love macro economics and Chetan's class and had to bid high to secure his course in term 5.

I plan to share as many thing taught by him in and out of the class on economics. As I've already mentioned, this is much for my reflection and will be glad if it helps some one else too. 

Currency Devaluation - India - 1991

Well, I was surprised to know that Greece in present shape (2011-12) is in many ways similar to what India was in 1990-91. Back then, India was facing huge debts. Actually, huge foreign debts. Just like for any human being who he is in debt, any nation has only two options left. One, generate steady immediate source of income and two, cut back personal spending on unnecessary stuff (national expenses on unproductive activities). 

Now, there is a glitch here. As i said, the debts that India had are not internal. They are huge FOREIGN debts which have to be paid back in FOREIGN currency. HOW DO WE DO THAT? For this we shall use some simple numbers and ratios:

E(Re/$) . Let us call this thing as exchange rate(of how many rupees is a dollar worth of). Currently it is around 57 INR . Back then on 1990s it was around 30-35 INR. I shall state a simple ratio now: 

Relative Prices = Price of US Good *  E(Re/$)/ Price of Indian good

Now, if I have to increase income and thereby increase my foreign currency levels, I need to EXPORT more good. How do I do that? I can increase my exports by reducing my price drastically in comparison with similar goods abroad. This is done by devaluing our indian currency(By rising exchange rate E(Re/$)). Now when I  increase E(Re/$),  RELATIVE PRICE of indian good over US is decreasing as per the ratio above. 

So, whenever, our  exchange rates rise(which means our price of good become cheaper relatively), it is evident that the value of indian rupee falls in comparison with relative country.

And our govt along with RBI, managed to (How? we shall come to that next) increase exchange rate (it rose to above 40 INR) level, thereby making indian goods cheaper and globally competitive. This rapidly increased indian exports and indian treasury started getting filled with foreign currency with which foreign debts could be repaid. Thus devaluing currency helped generate income and save our day. 

However, now Greece is part of Eurozone and it doesnot have monetary independence to devalue its currency (which is Euro and is managed by ECB) . So, only option left for its govt is to cut back on spendings on unproductive activities. These are typically, penison benefits, welfare programs etc. This is definitely against popular sentiment and will not go well with public. Hence so many protests and changes of govt heads. In short, all hands of Greece are tied up to come out of foreign debts. One solution would be to come out of Eurozone and have independent monetary policy. Time has to tell how things would evolve. 

China and US

China is known for keeping its currency artificially undervalued. This makes chinese goods very cheap and US imports very costly in China. Hence there is huge flow of dollars from US to China (by selling chinese goods in large numbers to US). China is now sitting on a huge pile of US dollars. US asks China to appreciate its currency(why? :) Simple: When Yuan appreciates, US expects its exports to look cheaper and hence increase its exports to China. This expectation has caveats seemingly ) (by lowering the exchange rate: E(yuan/$)), which china doesn't heed to. 

Now, let us see how this appreciation and depreciation of currency is made possible. This is done by and Open market operations Committe sitting with RBI(central bank of a country in other countries). They buy/sell (suck/push) a currency in exchange of another currency. We shall see the financial dynamics sometime later in other post. 

If I am to appreciate my currency (ie to lower my exchange rate), I will have to make my currency scarce or/and make dollars abundant. So, if I have to make my currency scarce, I will have to suck out liquidity from my economy. However when you suck out liquidity, your prices go down . (MV=PY is the basis for this statement). This lowers inflation too. Bottom line is prices would go down, even in this case. But domestic growth rate would be impacted. When prices would anyway fall , either you depreciate or appreciate currency and will impact growth in the latter case, why would China heed to US requests to appreciate currency.