currency, trade, foreign-exchangeLet’s say there are two countries. We know the exact amount of money each country has in their respective currency. We know all the information about the countries. The number of people, their salaries, the resources that the country has, the price for the resources, the amount of money in the people’s bank accounts, the amount of money in all the companies’ bank accounts, the infrastructure, the amount spent in research, and whatever you need to know.
Now, one guy wants to travel and wants to exchange his money from his country in order to get money from the other country. He is the first one to do that, so he needs to estimate the exchange rate. He wants to know if one of his money unit is worth 0.5, 2, or 5 of the other country’s money unit.
How would he do that? Is there some sort of mathematical algorithms that could give him a good estimation?
Thanks
He should compare the price of baskets of goods in the respective country. One well-known example is the Big Mac Index.
Edit in reply to the comment:
What if the price of baskets is lower only because the country is poor or the people work for almost nothing?
Well, say, the rich country pays 100 Rich Country Currency Units (RCCU) for the basket of weekly necessaries (basic foods, shelter, transport) and the poor country pays 10 Poor Country Currency Units (PCCU) for an identical basket of weekly necessaries. Based on my approach, the exchange rate should be 10 RCCU to 1 PCCU. Now, we try to adjust for income: Say, the average monthly pay in the rich country is 1000 RCCU and 50 PCCU in the poor country. Then, the average income in eht rich country is 10 baskets and 5 baskets in the poor one. But: would that change the spot exchange rate?
I would argue, that it should not change the spot exchange rate - a traveller from the rich country, taking 100 RCCU with him, gets 10 PCCU and can buy one basket. Why should the matter that he only works 1/2 the time for his income change anything with regard to the prices? Of course, if we open trade in goods (and would not only 1 person travel), this price relation would change as each country adjusts their production with respect to their relative advantages in production.
In order to exchange his money directly, he needs to find someone who wants his country’s money and to give him the other country’s money. But as he is the first one to travel between them (and I extend that mean there’s been no trade so far either), no-one in his country has any of the other country’s money.
So he needs to find someone in the other country to do the exchange with. That person won’t do the trade unless they can do something useful with the money - either because they will be travelling to the first country soon, or because they can find someone else to trade with who will be. In practice, this restricted availability of people to do the exchange with is likely to mean getting a very poor exchange rate.
I would instead advise the guy to travel with some durable and portable goods or commodities that have value in the other country. He can then indirectly convert his money by buying the trade goods in his own country and selling them in the other country. The exchange rate for going via any particular goods can be calculated by reference to the relative prices of those goods in each country, perhaps after taking into account any costs of transport.
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