Mint parity
R = gold content of currency being priced / gold content of currency priced in
Section B's figures: 113.0016 / 23.22 = $4.87 per pound
Any gold standard question. The currency being priced always goes on top; check the direction by asking which coin holds more metal.
- 113.0016 grains
- Gold content of the pound gold coin
- 23.22 grains
- Gold content of the dollar gold coin
The gold points
Gold import point = mint parity - shipping cost
Gold export point = mint parity + shipping cost
Band width in % = 2 x shipping cost in %
Section B's figures: $4.84 and $4.90 around $4.87, a 1.23 % band
Whenever a question gives a shipping cost, in cents or as a percentage. Compute the points, then any arbitrage profit is the distance beyond the relevant point.
- shipping cost
- About 3 cents per pound's worth, New York to London. Express it in the same units as parity before adding
- arbitrage saving
- (market rate - gold export point) x amount, when the rate is above the ceiling
Quantity theory, the engine of the price-specie-flow mechanism
M V = P Q
With V and Q constant: % change in P = % change in M
Gold flow = the size of the balance of payments imbalance
Converting a gold loss into a price fall, which is the middle step of Hume's mechanism.
- M
- Money supply, which falls with a gold outflow
- V
- Velocity of circulation, assumed constant
- P
- General price index
- Q
- Physical output, assumed constant
Overvaluation at a restored parity
relative price level = home price index / partner price index (a RATIO, not a difference)
competitive parity = old parity / relative price level
overvaluation % = (old parity - competitive parity) / competitive parity
deflation needed % = 1 - (partner index / home index)
The 1925 sterling question, and any question about a fixed rate set at the wrong level.
- relative price level
- Example: 155/124 = 1.25, so 25 % dearer, not 55 - 24 = 31 %
- deflation needed
- Example: 1 - 124/155 = 20 %, smaller than the 25 % overvaluation because the base differs