Economics - The Power to Investments? 

The rumor says economics is too theoretical for us to make investments. While they have produced a stock of literature about making money, very few economists turn out to be highly successful investors. The failure of Long Term Capital, an U.S based hedge fund with Nobel Prize Laureates in economics on board, is a notorious example of how poorly economists can lose in investment.

However, despite of criticism and sarcasm of the practicality of economics in investment, ignoring economics is never a good idea for investors. Indeed, fundamental analysis is economics-based to some extent.

Further in this article, a very specific and operable investment idea based on economics theory or reasoning will be discussed so as to illustrate how to plug economics into the investments.

The story happened in foreign exchange market. With the U.S. financial system falling into a mess, the yen appreciated against the dollar remarkably from Sep 2008 to early 2009.

Is there anything that could give us some clue of this appreciation, bet on it and thus make handsome profits?

Yes, interest parity condition works.

Before the crisis, the Japanese interest rate  was already set at near-zero level for fighting against its domestic economic problems. Meanwhile, the U.S interest rate i* was around 5 percent as the U.S. economy functioned well at that time. Suddenly, a lot of problems of the financial system were revealed, and the fall of Lehman Brothers, once the 4th largest investment bank made everybody frightened. Lowering i* is thus an inevitable monetary policy. i*, as a matter of fact, approached near-zero level and remained there up to now. However, as Japanese interest was already near zero before the crisis, the interest parity condition easily predicted a sharp fall in e or the appreciation of yen.

To invest early in the yen, you only need to have the knowledge of interest parity condition, follow the mainstream belief of a sharp fall in i*, and know the fact that i is already near zero before the crisis.

Indeed, the yen’s appreciation closely followed the Fed’s decision of interest rate reduction as the following graph indicates:

Maybe you have missed the investment opportunity above. You can find another investment opportunity right now by using the same kind of analysis. Currently, both i* and i are at near-zero level. With the economy stabilized (if not recovered) and fears of inflation, increase of i* is already on the Fed’s agenda. Of course, an immediate increase of i* is unlikely, but i* will increase in the long term for sure. For the Japanese case, well, their interest rate has been near zero for quite a few years and it can hardly go up until its own structural problems are solved. And the consequence will be a depreciation of yen, which has already started to happen. If you have any idle yen, exchange for the U.S. dollar or others whose interest will rise.

Economics is studied mainly for purposes other investment. However, as investors, you have to keep your eyes open and put as much information in your consideration as possible. Not just economics, when you are investing in renewable, sciences helps. When you are investing in China, you’d better watch government’s actions closely.