Global Trade Center

Prepaid Cards

The electronic equivalent of the special check is the prepaid card, commonly used on many campuses to operate copying machines. You buy the card, often from a vending machine, for cash, say $10. You insert the card into the copying machine to make copies, and the cost of the copies is debited from the balance on the card until the $10 is used up. There are other uses of prepaid cards- for example, paying for tickets on the Washington, DC subway system. Prepaid cards are popular in Europe and extremely popular in Japan.
A more sophisticated version is the smart card or “electronic purse or wallet,” which embodies a microchip and can be used as a general rather than a specific means of payment. Users “download” cash from their bank deposits via an ATM machine or a specially adapted phone. Smart cards can be used for payment wherever merchants have the equipment to read them. Unlike credit or debit cards, no verification is necessary. This saves on telecommunications costs which can be 8¢ to 15¢ for a credit /debit card transaction. Consequently smart cards are viable for much smaller transactions-purchase of a newspaper, for example.
Smart cards have been slow to catch on. One reason is again network externalities. Merchants do not find it worthwhile to install readers because few consumers have the card. Consumers do not find it worthwhile to acquire the card because few merchants accept it. Moreover, although the cost to the economy of using cash is substantial, the cost to a consumer of an individual transaction is small. There is therefore little incentive to go to a lot of trouble to avoid it.

The foreign exchange market expanded rapidly with the breakdown of the Bretton Woods system of fixed exchange rates in 1971 and exploded with the large increase in exchange rate  volatility that began in the late 1970s. In 1977 trading volume in NewYork amounted to less than $5 billion a day (about $15 billion in 1998 dollars). By 1998 it had increased to $351 billion a day. Trading volume in London, the center of the world market for foreign exchange, was  $637 billion a day in 1998, and the worldwide total was about $1.5 trillion a day. By 2001, total trading volume had fallen to $1.1 trillion. One reason for this was the creation of the Euro, which replaced 11 national currencies. Another reason has been the consolidation of the banking industry, which has reduced the number of participants in the market.

Trading volume in foreign exchange is nonetheless many times greater than the volume of international trade. In fact, most foreign exchange transactions are related not to trade but to finance. For example, if a Japanese pension fund wants to buy U.S. government securities, it must change its yen into dollars. Indeed, as the volume of international financial transactions has grown, securities firms have increasingly become dealers in foreign exchange , offering this service to their customers themselves , rather than refering them to a commercial bank.

Every country aspires to maintain a balance of trade. That is the total of imports must be equal to total of exports. But both the export and import are measured with respect to a particular currency value. There are lots of influential factors that alter the value of currency. Even a drop in rain may affect the country’s currency value because it affects the balance of trade.
Many countries hold its reserve cash in dollars that too in millions of dollars. Say if a country holds $100mn. Now because of the current economic plunge the dollar significantly lost its value and indirectly all the world countries received a huge blow in terms of their resources. It is estimated for previous case the value may drop to $75mn dollars. Alternatively have people decided to use dollars in more economic way?
Drop in Dollar values

New dollar image

Now might have you heard the recent inflation figure of 1000% in Zimbabwe. People were found carrying millions and millions of currency notes that generate no value. This means the Zimbabwean dollar has reached a value of zero. Another important factor for drop in currency value is the savings made by people. If there are no savings then a country would be ill equipped to meet long term obligations and hence it will import more and more foreign currency which will lead to domestic currency fall. Factors like demand for particular currency, current political factors and natural factors all contribute to rise/fall in world currencies.

The different  patterns of use of various methods of payment also relative costs. For example, the cost structure in the United States strongly favors the use of checks and credit cards.

Although your bank provides you with “free checking,” checks are in fact far from free. The average checks costs 76c to process. Total processing costs for all checks add up to some $45 billion a year. Your credit card transactions are also “free” to you. But processing costs average 44c per payment and merchants pay a substantial discount (as much as 5%) to receive payment.

Why is it that you do not pay the true cost of these transactions? One reason for “free checking” is taxes. The receipt of explicit interest on deposits is taxable, while the receipt of implicit interest, in the form of free services, is not.Another reason is the nature of competition among banks. Typically, when there are few firms in a market-as is the case in most local banking markets-they avoid competing on price because of the danger of a price war. Instead, they compete in the services they provide. Free checking is one of these services.

Why don’t  retailers pass on to you the extra cost of them of a credit card purchase? Credit card customers tend to be wealthier and to spend more. Retailers may be willing to offer them a lower price-which is what they do when accept a credit card-because on the whole cardholders are better customers.

Float. The main thing that makes a credit card purchase so attractive to you, and so costly to the merchant, is delay. You receive the merchandise immediately, but you do not have to pay until the end of the billing period. In the meantime you earn interest on the amount of the payment. The merchant avoids having to wait for payment only by discounting the debt with a bank. Essentially the bank lends the merchant the amount of the payment until you pay it. The benefit of delay to you from such a transaction is called float.

Payments patterns differ across countries for a variety of reasons-legal, historical, and economic.

Some Legal and Historical Reasons. Some countries use checks and others use giro payments for reasons that lie mainly in their legal histories. The check evolved in the English-speaking countries. English courts viewed it as a variety of commercial bill of exchange. 21 The early recognition by English courts of the negotiability of commercial bills, and so of checks, made their use much easier. If a check is negotiable, you can sign it over to your bank, and your bank can collect payment through the clearing system. If a check not negotiable, clearing becomes impossible  and you yourself must present each check for a payment at the payer’s bank.

European courts did not regard the check as a variety of commercial bill, but rather as a variety of  personal order of payment. The personal order of payment goes back to the medieval money-changer banks  that we learned about in Chapter 6. These banks allowed their customers to make payments by transferring ownership of deposits. Initially, orders to transfer deposits were made orally, and they required the physical presence of all the parties involved-the payer, the payee, and the banker. The courts recognized transfers  performed in this way as constituting a final  discharge of a debt. The money changers had a rudimentary clearing system: transfers were cleared between banks by means of reciprocal clearing accounts that the banks held with one another.

Because European courts regarded the check as a personal order of payment, they did not recognize its negotiability. As a result, the giro proved amuch more convenient  method of payment-first the paper giro and then, more recently, the electronic giro. Most countries do now recognize the negotiability of checks, but the giro was become entrenched. The French government launched a major campaign in the 1960s and 1970s to encourage the use of checks. Then European preference for giro payments over checks has carried over to a  preference for debit cards over credit cards.

Understanding Stock Market Basics before you Trade

Earlier stock market was considered to be a destination for literates. But the interest and buzz among common man regarding the stock market is ever increasing. This is because people have started to realize stock market as a revenue generating source if dealt clearly. Stocks are considered to be the greatest invention in financial instruments. Hence a clear understanding of what a stock is and how it is traded becomes imperative in this scenario.

            Share is the starting point of all. It could be considered as the share in the ownership of the company. In other way it could be considered as the share in the share of the company. Hence a share represents a claim or ownership on the earnings and assets of a company. Hence when you hold more and more stocks (shares) it means that you have a larger claim on the company. But a shareholder will be one among the thousands of shareholders for the company. All the other shareholders have equal claim in the company as you have.

            Earlier if you have a stock then you will be provided with a stock certificate. It is just a piece of paper stating your ownership. But now where everything gets to electronic format stock certificates too have to be in electronic version. It has got a lot of advantages when compared to physical version. First is the ease and security of the certificates when it is traded. Earlier when someone intends to trade he has to be physically present in the stock broker’s office or in the stock market  to trade. But now due to such electronic format you could trade it with a mouse click.

Though it is literally said that you have a call in the ownership of the company it does not mean you can instruct the day to day workings of the company. For example if you are the shareholder of Toyota you cannot call the company and instruct which line of cars you should produce. The ownership is limited to one vote per share in electing the board of directors of the company. Generally the companies into stock market will convene annual general body meeting which invites all of its shareholders. There the company discusses its prospects, future plan and current business. The shareholders have the right to information from the company directors.

            So far we have discussed from the perspective of shareholder. It is equally important to know why the company wants to provide shares. The question is why a company should allow its ownership to get diluted. The simple answer is the need for more money to grow or to sustain in business. A remoter of a company cannot indefinitely release money from his pocket for the business expansion. A point is reached where there is a larger scope for improvement or growth but there is constraint of money. Now the company can go public and issue shares to raise money. Once it obtains the funds it can invest in funds and share the profit with its shareholders

Gains to trade in borrowing and lending

We have savers and wealth holders with an excess of purchasing power now that they wish to trade for purchasing power in the future. On the other, we have businesses and house holds needing purchasing power now to finance investments. Both groups stand to gain from trade.  

The gain to borrowers is obvious. Borrowing allows you to open your bike shop and to setup factory to produce the EZ shift. If these investments are sufficiently productive, you will be happy to pay interest on the loan – to pay back in the future more purchasing power than you received at the time you took out of loan. 

Lenders too gain from trade. The interest you pay gives the lender a better return than he could achieve otherwise. What are his alternatives? He could hold cash . But this earns no interest t all. He could make a productive investment himself. But finding productive investments is difficult. Some people are much better at it than others. The typical saver does better by lending his money to someone with a highly productive use for it than by making an investment himself.

As in this example, most foreign exchange transactions today are international  and involve bank deposits  denominated in different currencies. This was not always the case. Historically, distance and poor communications were  more important barriers than differences in currency. In the nineteenth century, a merchant in New Orleans would have found it just as difficult to pay a supplier in New York as to pay of the United States. Banks in New Orleans offered  “domestic exchange” -claims on New York deposits-as well as foreign exchange-claims on London deposits.

The introduction of the Euro, a common currency for 11 of the 15 member states of the European Union in 1999 has created a situation in “Euroland” not unlike that in the early United States. The member countries all use of the same currency, but they have retained their individual clearing systems and these are only partially connected. The European Central Bank operates a system called TARGET that links the large-value online payment systems of EU member countries. This enables large-value, cross-border payments to be made relatively easily. However, there is no link yet for smaller payments. As a result, the cost of making payments in Euros between, say Rome and Pairs has remained quite high (much like the cost of making a dollar payment between New Orleans and NewYork 200 years ago). A survey in 2000 found that the average cost of a 100 Euro cross-border transaction was over 17 Euros, with enormous variations from country to country.

The Foreign Exchange Market

The interbank market in foreign exchange is an international market, active around the clock. Its major centers are London, NewYork, and Tokyo.The prices in the foreign exchange market are the exchange rates we studied  in Chapter 4. For example, the exchange rate between the U.S. dollar  and the pound sterling might be $1.40 to the pound. This means, in our example, that Henriette would have to give up $1.40 of her bank money(deposits  at her bank) in order to obtain a claim on 1 of British bank money (deposits at a British  bank). Trade in the foreign exchange market includes forward transactions as well as spot transactions like Henriette’s. 22

Trade and the gains from trade

As you line up to be issued uniforms, you are surprised that no one asks you your size. Uniforms are handled out seemingly at random. However, trade soon sets things right. A frantic half-hour of comparing and swapping leaves everyone dressed in clothes that more or less fit. The gains from trade are obvious to see. As this example shows, people trade because they differ in what they want. The basis of trade is diversity.

An important advantage of trade is that it allows specialization. The grassy meadows of New Zealand are a perfect place to raise sheep and cattle. So, new Zealand trades wool and cheese for automobiles and computers. Were it unable to trade, New Zealand would have to produce everything. It would have to switch resources from raising sheep and cattle to producing automobiles and computers. But this would be highly inefficient. Because new Zealand is a small country, producing the limited number of cars and computers it needs would be very expensive. Without specialization and trade, new Zealanders would have less of everything.

Although self sufficiency sounds appealing, it makes no economic sense. Many of your needs can be provided for more cheaply by others; what you have in abundance or can produce easily is often scarce and valuable for someone else. Trade benefits everyone.