Alan and Bob each own a bar. Alan's is in very northern New York, and Bob's is just across the border in Canada.

As it turns out, at the beginning of this problem, a Canadian Dollar is worth exactly the same as the U.S. Dollar, and people are quite accustomed to using them interchangeably (including banks).

But, alas, the U.S. Government and the Canadian government get in a spat. So, the U.S. "devalues" the Canadian dollar 10%, so now they will treat it as worth 90 cents (U.S. currency). In retaliation, Canada does the same and "devalues" the U.S. dollar 10%, so they treat it as worth 90 cents (Canadian currency).

Enter Charlie.

Charlie goes to Alan's bar and purchases a 1 dollar drink and pays with a 10 dollar bill (U.S.). He receives, in change, a 10 dollar bill (Canadian). He then walks across the border to Bob's bar and purchases another 1 dollar drink, paying with a 10 dollar bill (Canadian), and he receives, in change, a 10 dollar bill (U.S.).

Charlie proceeds to continue doing this until he finds himself quite intoxicated.

I think it obvious that Charlie is gaining on these transactions. The question is.... WHO (if anyone) is losing out on these transactions?

(In reply to by )

You are incorrect about Alan and Bob losing money. The bar owners can take the $10 local currency and go change it in at the banks for $11.11 in foreign currency. They are only giving back $10 foreign in change, meaning they are "keeping" $1.11 foreign (which =$1 local) for each beverage. The bar owners break even, period.

It is then the banks (i.e. the governments who guarantee the banks' solvency) who end up holding the bag because they have assigned an artificial (i.e. non-market) value to the other country's currency.

Posted by John on 2003-11-06 17:59:32