Currency Arbitrage

Nov 11, 2006 by

As of today, one United States Dollar buys 7.8645 Chinese Renminbi. A year ago on this day, a dollar bought 8.0847 renminbi. So, what does this mean? It means that a Chinese with a given savings can buy more dollar today than he could last year. Likewise, an American can buy less renminbi now than he could last year. If trade only occurred between the U.S. and China, Americans could effectively buy less with a given amount of money now than in the past, and Chinese could buy more.

If you thought that the dollar was going to continue to weaken against the renminbi, you could go to the bank and ask for some renminbi to hold in your piggy bank. At a later point in time, you could then go back to the bank and ask to convert it into dollars at the new exchange rate. Unfortunately, many banks charge currency conversion fees ranging from 1-2%. This can take a serious bite out of any profits resulting from small currency movements.

Here is an example:
Imagine that last year, you had $100, and then converted it into renminbi at the exchange rate of 8.0847 renminbi per dollar. However, your bank charged you a 2% conversion fee. Now, imagine that you converted that money back to dollars a year later at the exchange rate of 7.8645 renminbi per dollar, with the bank again charging a 2% conversion fee. How much money would you make?

If there were no currency conversion fees, you would end up with:
($100*8.0847) / 7.8645 = $102.80

With currency conversion fees, you would end up with:
(($100*8.0847*.98) / 7.8645) * .98 = $98.73

Thus, as a result of the exchange fees, this investment would go from having a return of 2.8% per year to having a return of -1.3% per year. While neither is a great investment, as savings accounts are paying far more, that should be the least of an investor’s concern.

Investing in renminbi is, for now, far safer than investing in other currencies with far more irratic movements. Over time, a renminbi tends to buy more and more dollars. Other currencies, on the other hand, move more wildly in both directions. If the exchange rate had gone to 9 renminbi per dollar (a strengthening of the dollar), someone holding renminbi as an investment would have lost money, regardless of the size of exchange fees.

Also, at a given instant in time, it is physically impossible to arbitrage two currencies. If within an instant, you trade dollars for renminbi, and then trade the renminbi for pounds, and then trade the pounds for Euros, before trading the Euros for dollars, you will end up with exactly the number of dollars that you started with, assuming there are no exchange fees. So long as the market is efficient, it isn’t cheaper to buy dollars with Euros than with renminbi. (This statement should be obvious, not profound. If it is confusing you, ignore it.)

4 Comments

  1. I am going through a financial nightmare.
    This isn’t a good morning for me. I logged onto my checking account to discover that somehow a entity managed to ACH $500 out of my checking account. I only had roughly $380 or so in there. This isn’t the worst part.I scheduled multiple credit cards to be paid off through this checking account that already went through. All those transactions net me 3 MORE nsf fees. It gets even worse, even though I might convince Wachovia to refund most or some of those nsf fees, all the payments were bounced so I have 3 more fees (1 at each CC company). So I now have call 3 seperate CC companies, wachovia, etc. I am about to lose my mind.

    1 overdraft fee for the $500 transaction = $60
    3 NSF fees = 3 x $30 = $90
    3 return payment fees = 3 x $35 = $105

    &%$@#$(&……. here’s where it might get even worse. I’ll probably get a late payment fee because of the payments being returned. This will also hurt my credit score.

    Mother%$#)%##$… here’s where it might get nasty. Universal default might be triggered by these actions and I might get hit with finance fees accross the board. There’s one credit card where I get 0% apr so I’ve been carrying the balance. The finance charges will HURT.

    I have so many calls to make, many CSRs to beg, lots of cigarettes to smoke. I am not in a good state of mind at all.

  2. You should contact the fraud department of the bank that holds your checking account. Hopefully, they can straighten everything out.

    Now, for a nightmare of my own. In the past week, the Google ranking of “adampowell.com” for searches for “adam powell” has dropped from 1st to like 40th. Why could this be? Do you think that Google might be penalizing me for the quality of some of the blogs linking to my adampowell.com/invest site? All of a sudden, adampowell.com is a very low ranked result for almost any query.

  3. von

    Just did a quick search to see if I could figure out why your search results were dropping. Looks like you share the same name as the Neopets founder. At the moment, the number one site that I see is a wikipedia page, followed by a couple Neopets.com pages and interviews w/ the founder. Touch competition.

    I doubt that Google is penalizing your site–there isn’t anything spammy or shady about it. It just looks like it’s a contest between some big established sites and your own. You could also be hitting the “google sandbox”. If you don’t know what it is, a quick search should it explain it. Basically, a new site in Google is penalized for a couple months before getting back into the rankings. It happens to alot of people.

    Best of luck!

  4. von, thanks for the information. However, that still does not explain what is going on. The Neopets Adam Powell has been famous for years. I have had the top placement on Google for the query “Adam Powell” for at least the last year. I’ve owned this domain for over five years now, so I doubt it is the Google sandbox. My sister domain, adampowell.org, which I have owned for less than a year, has a higher ranking. That’s really odd, as adampowell.org has almost no publicly-accessible content.

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  1. Invest with Adam Powell » How to Invest in Renminbi - [...] Unfortunately, the blog entry that was presented at the top of the search results was merely about currency arbitragein…

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