At one time, the Canadian and US dollars were discounted by 10 cents on each side of the border (i.e., a...

Additional material

This answer is correct from a capitalistic point of view.  From a
mathematics or physics point of view, however, the man in the problem
did not actually pay for the drinks.  All those people who spent
Canadian dollars in the U.S. bar in the first place paid for half the
drinks.  Those who spent U.S. dollars in the Canadian bar paid for the
other half.  The "economic work" was done by those who gave up 10 cents
on the dollar by using devalued foreign bills.  The residual "potential
economic energy" of those bills was released by our inebriated
entrepreneur when he carried them across the border.

-- bkolb@arinc.com

This answer is correct from a capitalistic point of view.  From a
mathematics or physics point of view, however, the man in the problem did
not actually pay for the drinks.  All those people who spent Canadian
dollars in the U.S. bar in the first place paid for half the drinks.
Those who spent U.S. dollars in the Canadian bar paid for the other half.
The "economic work" was done by those who gave up 10 cents on the dollar
by using devalued foreign bills.  The residual "potential economic
energy" of those bills was released by our inebriated entrepreneur when
he carried them across the border.

-- <bkolb@arinc.com>, March 1994

[ Editor: the following exchange of mail between David L. Book and
Jonathan Haas (keeper of the rec.puzzles FAQ) took place in August
1996. ]

To my surprise, the answer to the cited problem in the rec.puzzles archive
has not changed in the two weeks since I first read it.  I therefore
conclude that no one has objected to it.  This is a pity, because it is
WRONG.

The right answer to the problem is that the people who acquired Canadian
or U.S. dollars at par and then traded them at 90% of their nominal value
are the one who paid for the currency trader's drinking spree.  [Their cash
holdings lost value because of the two governments' actions.  The individuals
involved did not actually suffer a loss, however, until they gave up
their foreign money at 90% of par.  After all, they could have made the trip
across the border themselves.  Then they would have lost nothing.]

It might be argued that the trader performed a service in transporting the
money.  Here is a _reductio ad absurdum_.  Suppose that, the day after
the events in question, the Councils of Economic Advisers of the two
governments reverse course and each declares that the other's currency is
worth 10% *more* than the domestic variety.  After recovering from his
hangover, our enterprising moneychanger begins carrying Canadian dollars
to the U.S. and getting U.S. dollars and beer in exchange, and vice versa.
At the point where he falls down drunk, all the money he repatriated the day
before is back in the hands and pockets of the foreigners who had it when
he started.  Nothing at all is different from the _status quo ante_, except
that a large quantity of beer has flowed through his system.  What is the
"economic work" he has accomplished?

Properly speaking, "economic work" is what economists are paid to do.  When
they are unable to do that, they resort to jargon and doubletalk.

-- David L. Book <book@astro.umd.edu>

I'm no economist, but I still support the archive's answer.

Economic work consists of moving goods from a point where they have
lesser value to a point where they have greater value. (This, along with
increasing the value of goods by adding labor, is the very fundamental
basis of wealth creation.) Consider the problem slightly differently:
Mexico produces tequila, which is cheap and plentiful there, so sells
for US$0.90 per liter. America has a high demand for quality Mexican
tequila, and it can be sold for US $1.00 per liter. But American
widgets, which can be purchased for US $0.90 per dozen, command a price
of US $1.00 per dozen in Mexico. Now, our budding entrepreneur can start
with his dollar, buy a dozen widgets in America and have a dime left
over, buy beer with the dime, then head south, sell his widgets for a
buck, buy a liter of tequila and another beer, then go back to America
and sell his dollar's worth of tequila, and so forth.

It's almost analagous to gravitational potential energy. With respect to
tequila, America is "downhill" from Mexico, and with respect to widgets,
Mexico is "downhill" from America. Our alcoholic trader simply moves
things from an area of high potential to an area of low potential and
collects the difference in "energy" as beer.

This problem uses currency, rather than goods, which adds a bit of
obfuscation but doesn't change the workings one bit. (The problem
further obfuscates by calling both currencies the "dollar".)

Events can change the flow of goods, true. If the governments declare by
fiat that the value of the currency has changed, what they essentially
do is rob holders of one currency to give a boon to holders of the
other. The economic potential of the currency also changes, and so yes,
the trader *can* make money now by working his trade in the other
direction. This isn't a _reductio_ad_absurdum_, just a fact. Even though
government actions can look pretty absurd at times :-)

-- Jonathan Haas <jhaas@microsoft.com>

It's clear, but I still feel it's wrong.

Would you walk through shoulder-deep snow, braving wolves and wild moose
and Inuits and so forth, just to get a ten-cent beer?  Of course not.  But
the problem asks us to assume that the moneychanger is willing to do it.
We have to assume, then, that his overhead in shoe leather and wolfbite
medicine is less than ten cents per pass.  It follows that anyone else
could have done the same at no greater cost, since he employs no advanced
technology, economies of scale, or other secret weapons.  Those who
refrained from cashing in were just making a gift to the MC.

Perhaps they are all corporation lawyers and Microsoft engineers, whose
hourly wage is so high that it's not worthwhile for them to schlepp back
and forth across the border just for parking meter money.  In that case
the governments are responsible for the loss and should compensate them
for the "taking" of 10% of their foreign currency holdings.

The communist governments of eastern Europe (and many in the third world)
used to operate like this, setting currency prices arbitrarily.  The result
was inequitable transfers of wealth, stifled trade, and the fostering of
black markets.  It is not how money markets work.

The process of money factoring does not by itself create wealth.  In your
analogy, there is no gravitational potential gradient here.  Ask yourself
this: how did money get repatriated before the double devaluation episode?
Canadian dollars must have found their way back to Canada and U.S. dollars
to the States.  It wasn't necessary to pay agents a 10% fee, was it?  But
it got done anyway, and the same amount of "economic work" was involved.

I've reread my messages and your reply, and see that I've allowed you to
deflect me from my point.  The question isn't if the MC *worked* for the
beer or whether he deserved it or should pay taxes on it.  The question is,
where did he get the money to buy it?  The answer to that, obviously, is
from his currency dealings.  And since he dealt only with holders of
foreign currency, he got it from them.  The price of the beer was
transferred from their pockets to his.

-- David L. Book

Sorrrrt of. Again, consider the case of a tequila maker. It costs him,
oh, say, $0.45 per liter to make it, and he sells it for $0.90 per
liter. John Tequiladrinker, who lives maybe fifty miles away from the
tequila maker, is willing to pay $1.00 per liter for it. If our
entrepreneurial moneychanger buys up a bunch of tequila from the source
for $0.90 and sells it to John for $1.00, would you say that his $0.10
per liter profit comes out of the pocket of the tequila maker? Not
really. The MC is doing work by moving the tequila from a place where
it's valued at $0.90 per liter to a place where it's valued at $1.00 per
liter.

It's the same thing with the currency. Don't let the fact that it's
currency distract you from the fact that it's still a commodity, valued
more in one place than in another, and work is done by moving it from
where it's less valuable to where it's more valuable.

By the way, I highly doubt that this is based on a true story. If two
governments really did devalue each other's currency in the way this
story is written, there *would* be a flood of border-crossers exchanging
currency for mass profit.

-- Jonathan Haas

> would you say that his $0.10
> per liter profit comes out of the pocket of the tequila maker?

No, he gets it from the buyer.  It has to come from SOMEplace.  If there
were no sale he could move the tequila all over creation and never realize
a profit. But in this example he is being paid for a service (delivering
booze).

> The MC is doing work by moving the tequila from a place where
> it's valued at $0.90 per liter to a place where it's valued at $1.00 per
> liter.

True, but irrelevant.  If the seller transports the tequila all the way from
the distillery but succeeds in getting two dollars a bottle, he has profited
hugely at the expense of the buyer.  If he obtains the tequila by hijacking
a tank truck and then sells it for a dollar half a block away, most of his
profit would be at the expense of the previous owner of the tequila.  In the
case of the beer-swilling bordercrosser, the barkeeps got their usual payment,
but the people who lost out by devaluation didn't, so the case is analogous
to a hijacking.

> It's the same thing with the currency. Don't let the fact that it's
> currency distract you from the fact that it's still a commodity, valued
> more in one place than in another, and work is done by moving it from
> where it's less valuable to where it's more valuable.

Don't you be distracted by the fact that the government was responsible
for stopping the truck.  It's still a hijack.

-- David L. Book

I'll try again, using your tequila example.

Suppose I buy tequila from a distiller in Juarez and truck it to
a distributor in El Paso.  Let's stipulate that normally I pay
the distiller 90 cents a bottle and the distributor pays me a dollar.
By "normal" I mean that this price pattern has been established in
a reasonably free market involving several competing distillers,
truckers, and distributors; that, adjusted for inflation, it has been
stable over a period of years; and that all participants receive
comparable returns on their capital investment, say 10 percent
annually.  Does that sound normal to you?

Under these conditions, as you pointed out, it makes no sense to
say that the wealth I acquire comes from the pocket of the
distiller or that of the distributor.  I work for it.  I earn it
by performing a service that benefits both of them.  No one is
being exploited.

Now let us assume that something happens to upset the normal price
structure.  Perhaps the Mexican government requires all distillers
to sell tequila at a fixed price, or racketeers move in, or the
Bronfmans start a price war.  Anyway, the new shipping price is 50
cents a bottle.  If the distiller can't arrange to buy his mescal or
potatoes or whatever he uses at a big discount, he will lose money
on every order.  Assuming that the distributor continues to pay a
dollar, I am going to clean up.  And it is clear that I am doing
so at the distiller's expense.  I am getting rich and he is getting
poor.  I am still performing a service benefiting the distributor,
but he is paying the same amount as before.  My windfall is coming
out of the distiller's pocket, not his.

This example would fail if we didn't have an idea of the "normal"
price.  In that event we might wonder if the farmer who supplies
the mescal was overcharging, or if the distiller was paying too
much to his workers or for maintaining his equipment. But as I have
stated it, the source of the distortion in prices is manifest.  Of
course, the distiller might not always be the loser.  If the U.S.
government decided to control the prices of alcoholic beverages and
limit the retail price of tequila to a dollar, than either the
distributor would lose his shirt or I would.  Or more likely,
tequila would soon become impossible to find in El Paso, or a black
market would develop.

What does all this have to do with the cost of beer on the Canadian
border?  At the risk of belaboring an obvious point, I assert that
the double devaluation in the original problem changes the transaction
from normal to abnormal.  The distorted prices no longer reflect the
real value of goods and services.  The holders of foreign currency
are getting ripped off.

In some transactions it is possible to identify a winner and a loser:
when the Dutch bought Manhattan for 24 dollars or when George Soros
made a billion dollars in a month speculating against the British
pound, someone got rich and someone else lost big time.  It happens.
And in those cases you can't just balance the books by calling it
"economic work."

-- David L. Book <book@spp.astro.umd.edu>