BLOGNAME: LOUDER THAN WORDSAn informal, stream-of-consciousness reflection on business ideas, events and issues in modern business, modern life and with some specifics to the web-software industry by Paul Tomori, Internet Entrepreneur
|The Ultimate Arbitrage|
By Paul Tomori
Monday, October 25, 2010 at 17:33:45 (EDT)
Imagine that you are a land-owner and you have decided to let your land out to two types of tenant farmers. One manages pigs and the other one cows. These farmers pay you a monthly rent for the use of the land.
The animals are segregated enough to keep the peace and for sake of argument, let's say that all the livestock are equal in size and health. Let's also say that a pig and a cow are more or less equal in value, but subject to value fluctuations depending on their demand.
And let's say that the tenant farmers are constantly setting the demand by bartering their pigs for cows and vice versa. Your role as the land owner is to keep a log book of all the trades. Some days, the pigs are worth a little more than cows and other days cows are worth a little more than pigs.
There is constant ebb and flow in the total number of cows and pigs on your land, but generally the number ticks upward pretty steadily. I guess you could say they are "multiplying"!
Now imagine that for every 100 livestock that get traded, you get to keep 2 of those livestock from the each side of the trade!! That's right. You get 2 pigs AND two cows just for "logging" the trade and providing insight as to the relative value of each animal on that day at the moment of trade.
Now let's say that there are about 10,000 of each animal on your land and that in any given day, perhaps just 500 animals will change hands.
The animals don't actually have to be moved when they change hands. You just have to keep an accurate logbook accounting of who owns what and in what quantity.
This is essentially a risk-free situation for you. You get rent AND you get a piece of all the transactions that happen every day.
Wouldn't that be the ultimate arbitrage?
Welcome to the North American bank system!
If you think of Canadian dollars as pigs and American dollars as cows and if you imagine a bank like TD that has hundreds of U.S.-based locations, you can see that such a bank would have thousands of depositors in their roster, some of whom, on a daily basis will trade their CAD currency for USD currency.... and vice versa.
Without having to actually go out and buy any currency (because the bank has ample amounts of both types on deposit), all the bank has to do is keep an accurate log book, charge a nice monthly fee and hit up its customers for about 2% of every currency exchange. That's 2 percent on BOTH ends of the trade.
Nice, if you are the bank anyway!
If you are a small business and you have an American customer base, do yourself a favour and get a US currency account in which to deposit your US checks. You'll avoid the 2% arbitrage that the bank will hit you with on each deposit and if you play the game right, you can just hold on to your dollars until exchange rates are more favourable to you in the future than they were for you in the past when you originally got paid.
Better yet, invest your US dollars in U.S. equities or bonds and make that cash grow without ever having to exchange it.
Of course, you have to pay taxes on the earnings regardless of currency and at some point, you'll either have to exchange it or go and spend it in the currency country of origin, but you'll do so a lot richer if you sweat the small transaction fees along the way.
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