Investments and interest rates

Interest rates of Monetary Policy Chile v/s USA
(January 2007 - July 2008)

Blue serie : Central Bank of Chile interest rates - Yellow serie : FED Interest rates at US

It is easy to depict a relation between the interest rate and Investments and we usually say when the interest rates increase Investment diminishes because people have strong incentives to save their money at the banks.

If we ask about the real effects of the interest rates on the economy we could find real examples as it is the case of this large supermarket chain at Chile ( Santa Isabel ) implementing an aggressive investment program in 2008 thought as 10 new supermarkets in different areas of the country. The total investment totalize M$ 60.000 dollars and before a month they are planning to open at least 5 new locations giving employment to 544 people during all the life of this new investments.

We assume the life of this kind of projects to be said at least 20 years so, in this sense we can think in this positions as new jobs for 544 people during the next 20 years. This fact is very inportant, not only for the investments but the families of this people now facing new posibilities in their lifes and because it is exactly what the goverment must evaluate for this particular situation.
But we have seen recently the Central Bank of Chile raising the interest rates ( July 10, 2008 ) from 6,25 % to 7,25% in a year. The stock markets has reacted inmediatly decreasing its price indexes in more than - 1 % in both indexes , said the IGPA and IPSA.

This dramatic fall in the stock markets prices are reflecting the real fact of that market internalizing new increases before the end of the year to reach levels near to 7,75% in operations between the Central Bank of Chile and the entire financial system.

Note this situation in the United States of America has been exactly the converse of what we saw during this last year in Chile. The FED has been pledging for new reductions in the interest rates. In this sense we would have to ask our-selves why the Chilean Central Bank is increasing the interest rates thought we would expect the Central Bank controlling the inflation rates with decreasing rates in the monetary supply instead of using the interbanks operation interest rates as a mechanism of control.
If there is an inflationary target to achieve (a nominal variable) again we would expect the Central Bank cutting the Monetary Supply (nominal variables) and the Goverment reducing their expenses to control the first one. In this way both the Independant Central Bank and the Government might reach their goals with no use of the interest rates.

The effect of a reduction of the interest rate is to reduce the private consumption and Investments, forcing to the entire country to sacrifice present consumption and present investments in an artificial way. This is , because in a small open economy we would expect the inflation rate adjusting to capital inflows troughout the country and the world.

Finally we would expect again the goverment pursuing real policies to increase the Gross Domestic Product , reducing the interest rates to levels near of 2,25 % as it has been in the United States of America where the FED has been cutting the rates to increase the economic activity.

A new can design and lagged markets

Sometimes we ask why there´re countries where innovation and new products takes time to be placed related to more developed markets. This is the case for this design of a Budweiser can. Despite the fact of strategic concerns we can think in "sunk costs" where indivisibility, the posibility of inaction, and irreversibility exist. We ask why in large markets as it is the case of USA, consumers can buy these cans, said aluminium bottles instead of the traditional can.
We assume this kind of cans are more easy to handle and they are prefered than a traditional can. The new design requires new technology or at least the firm needs to invest money making arrangements at the production facilities. This investments are irreversibles due to their specificity and there´s inaction posibility, so we face sunk costs
In this sense we need to reach scales to make the new technology more profitable than the existing one and in this sense the unit cost will be less than the prevailing with the old technology.
Still the firm will have to make a hard investment in Research and Development (R & D), adapting technologies and even in new advertisement. The firm needs to evaluate the project of putting the new product in the market and it seems obvious they need to reach certain scales ( a greater market share ) to cover the new additional investments, fixed and variable costs.
The USA Food & Beverages market is a large market and the new required scales can be reached faster than it could be in any other market. So we could expect the innovation to be placed first in these markets than in latinamerica. If we think in the South Region Food & Beverages market (said beverages and beers) and we consider Chile, Brazil and Argentina we could expect in the long run this kind of cans being placed at the local market.
So we could expect the required time to place innovations at the market being related to the size of the new sunk investments and sunk costs. First we need to reach enough scales economies where the new technology will be more convenient and then make new expenses in specific advertisement to the new product and in this sense there´s inaction posibility but once the decision is taken firms need to sink costs to crown the market.

Profit and non Profit Organizations

I want to write about this issue because I´ve felt temptated to name this site "My Think Tank" instead of "My Blog", thinking about the concept as a a bucket full of ideas and this is not true.

A Think Tank is so far much than this and in a fast search I´ve found the following definition :

A think tank (also called a policy institute) is an organization, institute, corporation, or group that conducts research and engages in advocacy in areas such as social policy, political strategy, economy, science or technology issues, industrial or business policies, or military advice. Many think tanks are non-profit organizations, which in some countries such as the US and Canada provides them with tax exempt status. While many think tanks are funded by governments, interest groups, or businesses, some think tanks also derive income from consulting or research work related to their mandate.

After read this paragraph you will understand clearly what are the main objectives of that organizations and you will see they usually are non-profit organizations.

So I´ve remembered about the main distinctions about profits and non-profits organizations. But in economics we say firms (we don´t make distinctions between both types in our General Equilibrium Models) are maximizing profits as well as the consumers are maximizing their utility functions. And this point is very important because the efficiency in General Equilibrium Theory is when all the firms and consumers are using efficiently every input and output respectively given their prices. They are getting profits as in perfect competition and there´re no wasted resources and all the system get a whole equilibria.

In management instead we have to deal with profits and non profits organization and the last ones claim to be efficient as well as any profit organization. But this is not true because we are talking about different concepts.

Unfortunately the main objective of a non-profit organization is to provide a good or service in an enought quantity to cover all the requirements of the members or the beneficiaries, not withstanding the profits but instead the budget, this is, they will provide the service meanwhile they can pay the costs. So in this sense we have non-profits organizations which are providing goods and services in a large quantities probably until they equate incomes to costs.

This is not the rationality of a maximizing profits organization, e.g. the firm. The firm is all the time optimizing and maximizing profits and they will provide the goods and services until they get the Maximun difference between Incomes and Costs, this is when they are maximizing profits.

If the firm is providing a large amount of a good or service to the point where the income equates the costs we talk about efficacy, this is they reach the targets but they don´t necessarilly maximize profits, so they are not efficient. Instead the firm is Efficient and have the Efficacy property at the same time, because they reach the given objectives to maximize profits.

In the figure above we find a profit organization which maximize profits where the second derivative of the income equates the second derivative of the costs function (Qprofits) and inmediatly we find a non-profit organization providing a larger quantity (at the green line) than the firm but they are not maximizing profits (Qnon-profits). We can think in an organization which provide with breakfasts to people in poverty, they will continue providing breakfast until they can cover the costs and expenses with the Income (Income = Costs).

So the firm is efficient ( they are maximizing profits) and they reach their objectives in quantities defined to acomplish that goal and even they have the property of efficacy.

Instead the non-profit organizations meet the efficacy property because they reach the goals but not efficient at all, because they are not maximing profits.

I hope many respectable Think Tanks will understand they are not efficient just because they are not maximizing profits but instead they are providing a service which is equally valuable by the society as a whole.

So at the light of this reflection I´ve decide to avoid the title "My Think Tank" and I´ve decided to keep the words My Blog.

Driving in the Highway : The Market

The first time I felt the experience of going at fast speed in the highway ( the market ) was when I was working at the bank. I was an executive manager and the customers were mainly exporters and sometimes importers. Exporters are supposed to sell their production usually in US currency and Importers are assumed to purchase their supplies in US currency. It is the most frequent situation and it was exactly what I had to face.

When you are trading currencies you are in the highway at fast speed, you have to quote all day the exchange rate for your better clients and still make every business a profitable one. Outside the US, Exporters are Supplying US currency to the local market ( they need local currency to pay their expenses) and Importers are Demanding US currency to pay their external supliers.

Early in the morning after reviewing the unpayable checks you begin the day with people asking you for exchange rates and you have to quote with the trade room the best exchange rates for your clients even they are importers or Exporters ( you are giving a service ) and of course caring for the profitability of the operations.

If you are dealing with an exporter they want the highest exchange rate you can get at the market but this will depend on who is this particular day quoting and trading at the trade room.

In the local market the mainly exporters are companies in mining so they liquidate US currency to convert it in local currency, when great exporters companies enter into the market selling dollars you are in problems the Law of Demand and Supply operates and due to the large supply of US currency, this means the US exchange rate will be priced probably at lower levels than previous days.

Your customer is in problems he wants the best conditions for his exchange rate and you can´t get a better rate than the previous day. But still remains the possibility of greater importers entering in the market and increasing the Demand and you could get a better exchange rate, so you are hopeless and still keep your-self quoting with the trading room. Sometimes in the middle of the day the exporters take deffensive positions and wait for a better moment, in this moment you have the pulse of the market at your fingers and you feel you are in the highway at top fast speed.

You keep your hands on both phones quoting exchange rates and probably quoting a special interest rate with the trade room. At this moment you are working not at your office rather you are part of the team, you are inside the trade room and doing your best for your customers and your company.

Again, now you are driving at top speed in the Highway :

... The market.

I think this experience to feel the market in your hands and living every second to understand what goes on during the day to get better quotes and transactions is the best lesson about how a market works. It is so simple when the demand increase (ceteris paribus), the price of the US currency will be higher and if the supply increase (ceteris paribus) the price of the US currency will decrease too. So simple like that , The law of Supply and Demand in motion. Enjoy it !