Hi DJ, help me out with identifying these islands:0) Have I borrowed the correct and doom island's currency?
Asia Pacific: A Tale of Three Islands
morganstanley.com
Andy Xie (Hong Kong)
Once upon a time there were three islands in a big ocean. Two of the islands were small and had one thousand people each. The other was very large and had five thousand people. They all ate bark to sustain their miserable lives and napped to pass the time.
One day the less populous islands found more productive ways to spend their time than napping. One discovered how to grow rice; its people promptly switched from bark to steamed rice. The other learned how to fish; its people started to enjoy sashimi. They created new economies.
The newfound prosperity allowed some of the people on the two islands the luxury of studying economics. After pondering the matter for days and nights, they realized that the people on the two islands could improve their living standards further by trading with each other. The diet on both islands could include steamed rice, sashimi, and sushi if they found a way to trade with each other.
To facilitate trade the two islands decided to create central banks to issue paper currencies. The currency of Rice Island was rice dollars or R$, and that of Fish Island was fish dollars or F$. The central banks were mandated to maintain price stability. They issued just enough paper money to keep the price of rice at R$1 per bowl and the price of fish at F$1 per fish. (In this wonderful world all fish were the same size.) It turned out that when supply was equal to demand in bilateral trade, one bowl of rice was worth one fish. The exchange rate stabilized at R$1/F$1.
Financial deepening then developed on these two islands. Rice Island incorporated its fish production into a company, Rice Co., which was owned equally by the island population. The people of Rice Island all worked for Rice Co. and received their wages in R$. Their shares in Rice Co. entitled them to dividends from the company. The wages plus dividends equaled its GDP.
To improve liquidity a stock market was established. Since trading stocks required money, the Bank of Rice Island -- the central bank -- happily issued more money. The extra money stayed in the stock market and didn't cause any inflation. Fish Island wasn't far behind in financial innovation. It incorporated fish production into Fish Co. and also set up a stock market, which was as successful as that of Rice Island.
The people on the big island were a bit slow. They still ate bark, while the people of the two small islands dined on sushi while buying and selling stocks for fun. They were called Bark Island by the people of the other two islands. They had no fish, no rice, no money, and no stock market. Life was as miserable as ever.
They became more and more anxious watching the small islands prosper. One day the people of Bark Island gathered together and decided to modernize. They chanted, "Getting rich is glorious." They believed they could learn to catch fish if they could get a person from Fish Island to teach them how. Growing rice is quite high tech, and it takes a long time to get the soil conditions right. So the people of Bark Island first tried to catch up with Fish Island.
Sure enough, a person from Fish Island defected and taught two people on Bark Island how to catch fish. These two skilled workers taught four other people how to catch fish. This process went on, and the number of skilled workers on Bark Island grew exponentially, as did its fish production.
Bark Island then decided to modernize its finances. It set up the Bank of Bark Island and created a currency called cheap dollar or C$. It incorporated its fish production into Cheap Fish Co. and floated it in the newly created stock market.
Of course, the people of Bark Island weren't satisfied with just eating sashimi. They also wanted steamed rice and sushi, so they sent a trade delegation to Rice Island and offered two fish for one bowl of rice. The people of Rice Island were ecstatic and took the offer. Bark Island also pegged C$ to R$ with a fixed exchange rate of 2. The fish price began to decline from R$1 to R$0.5.
The CPI on Rice Island was comprised of the average of rice and fish prices. It began to decline with cheaper fish imported from Bark Island. The Bank of Fish Island saw deflation and decided to fight it by increasing the money supply. It could raise the rice price to R$1.5 per bowl while the CPI still remained stable.
As the rice price started to climb from R$1 to R$1.5, Rice Co.'s profits rose rapidly. Stock market strategists saw growth and told investors that Rice Co.'s valuation should be much higher as its earnings were growing much faster than before. They claimed this was the "New New Economy" with much faster productivity growth. As earnings continued to deliver positive surprises, the stock market strategists became stars. Their words were followed closely by the people of Rice Island.
At first the Bank of Rice Island complained about "irrational exuberance" but continued to increase the money supply anyway, as the demand for money for buying stocks rose. As the stock market kept rising, the officials at the Bank of Rice Island began to question conventional wisdom and started to embrace the "New New Economy" productivity miracle. They merrily went on increasing the money supply to the stock market. There was no inflation! Why not?
In the meantime Fish Island saw fish demand from Rice Island disappear. The new international price for fish was one for R$0.5. Further, the rice price rose from R$1 to R$1.5. Fish Island's CPI was also the average of the fish and rice prices. If it held its exchange rate stable, its CPI would also remain stable.
However, its living standard was dropping. Its fish production was worth less rice over time. Further, the stock of Fish Co. was collapsing. The declining fish price led to negative earnings surprises again and again. The people of Fish Island felt poorer by the day and wanted to cut back their consumption. Deflation occurred anyway, even as the rice price was rising.
Eventually, Fish Island decided to devalue its currency to protect the profitability of Fish Co. The exchange rate between F$ and R$ rose to 2 from 1. Fish Island's prices converged with those of Bark Island. Its living standard also converged with that of Bark Island. It was a bitter medicine to swallow. For ages the people of Fish Island had looked down on their poor cousins on Bark Island. Could they accept that they were no different? |
