Magic money?
December 25, 2007 9:34 AM   Subscribe

I loan an amount on Kiva. Lets say it's $25, which at the time of lending is £12 GBP. When I get the money back 6 months later, I get £13 GBP back.

Where does the extra £1 come from? Bonus question: Could I theoretically make money by putting it in different banks around the world and then withdrawing it to the UK based on how much the £ was worth at a given time?

I know next to nothing about international trade, and the value of the EUR vs the USD vs the GBP etc. Please bear this in mind when responding. :)
posted by Solomon to Society & Culture (17 answers total) 2 users marked this as a favorite
I'm trying to understand this question and don't think it really has anything to do with Kiva, other than that a loan there led you to think about this. Is that right?

Do you know how to make a small fortune in the foreign exchange markets? Start with a large fortune.

You can make money and you can just as easily lose money. If there were certain knowledge that the value of the euro were going to decrease to a certain value, all of the big currency speculators would sell their euros, until the euro would have decreased to that value. So you really can't deterministically make money at this—it's a gamble unless you have more better information than big financial firms.
posted by grouse at 9:47 AM on December 25, 2007

Response by poster: No, it's nothing to to with Kiva per se. That's just the vehicle by which I spotted this happening.
posted by Solomon at 9:50 AM on December 25, 2007

The first part, the extra pound, is provided by the person/people who used your money for a loan. It's interest. The bonus question is best answered with a word that you should look up and research: "arbitrage." It's difficult.
posted by rhizome at 9:54 AM on December 25, 2007

Best answer: No, the extra pound isn't interest. Kiva doesn't pay interest.

What happened is that the exchange rate between GBP and USD changed. When you loaned the money, you exchanged it for USD at about 2.08 USD per GBP. When you got the money back, you received USD that were exchanged at a rate of about 1.92 USD per GBP.

In other words, you loaned some USD via Kiva. While the loan was in effect, the value of the USD went up relative to the GBP, so when the loan was redeemed, you were able to buy more GBP than you initially had to spend to buy the USD. This is the same as if you had bought something and then sold it later for more than you paid for it.

Theoretically, you could make money on the foreign exchange market (some people do), but in order to do so you'd need to be able to predict how exchange rates will change in the future, which is not easy to do.
posted by ssg at 10:30 AM on December 25, 2007

Asking where that money came from is kind of like asking where an idea comes from. Money is an abstract representation of value, not a concrete measurement. The relative values of currencies are to a large extent a matter of people's current opinions about the future success and financial integrity of the governments backing them.

It seems as though the dollar strengthened against the pound during the term of your loan. In my opinion, the US is now in such deep financial trouble that in the medium term, the dollar is actually actually more likely to weaken further against other currencies, in which case you would end up with fewer pounds than you started with if you repeated the trick.
posted by Estragon at 10:51 AM on December 25, 2007

That really seems like a sham that Kiva does not give you interest. Especially because they allow the "field offices" who facilitate the loan of your money in the local destination, to charge the loan recipient interest.

So basically you put up all the money so some foreign lender can charge the working poor 21% interest on a loan. Fucking great. Nothing in it for you and the interest rate is practically predatory to the impoverished recipient who's supposed to be getting a lift out of poverty from all this.
posted by scarabic at 11:06 AM on December 25, 2007 [2 favorites]

New money is created literally from nothing, most of it by banks. Central bankers provide a base of currency, and banks then take that base and multiply it through a process called fractional reserve lending.

We think of money as an asset, but it's not a hard asset anymore. It's debt; it's a claim on future production of the economy, with no inherent worth whatsoever.

So, when you lend out money at interest, and get more of it back, where did the new money come from? Most directly, it came from other people who paid your debtor, who then paid you. But, fundamentally, new money originally comes from nowhere, waved into existence by a magic wand.
posted by Malor at 11:08 AM on December 25, 2007

Scarabic, that's off-topic, and not terribly well informed. I don't know a hell of a lot about itmyself, but I understand that interest rate is fairly standard across the microcredit lending field, and similar to that charged by Grameen Bank, founded by Mohamad Yunus, who won a Nobel a few years ago for coming up with the idea of microcredit. The rate has to do with the administrative costs of administering so many tiny loans: you still need to hire loan officers to administer them, they need a place to work, etc.

Kiva is a charity. You put up your capital, and it ain't about getting a return. And rather than just giving a man a fish, you're helping them start a fish farm. It's not everyone's idea of what charity should be, but it is intellectually coherent.

The banks, on the other hand, are in it to make a profit. That's part of the beauty of the system.
posted by hwickline at 11:19 AM on December 25, 2007

...And (to add on to hwickline's point) traditional moneylenders in these rural locations sometimes charge wayyy in excess of 21% because there are no alternatives, no bank on the corner with savings accounts and loan officers.

But to Soloman's question, this video may be interesting to you:

Money as debt
posted by sharkfu at 12:07 PM on December 25, 2007

Best answer: Bonus question: Could I theoretically make money by putting it in different banks around the world and then withdrawing it to the UK based on how much the £ was worth at a given time?

Yes, but transactional costs will likely eat away at any profit you might receive. There are a variety of domestic investment vehicles which can earn you more profit, at far less risk to your capital.

Currencies are a very volatile form of investment. It is not unheard of to see currencies see 1,000% or more change in a single day. Theoretically you can operate so that you would never see the downside risk, but it would require a lot of capital to do so. A good example is George Soros who stood to make, and did, a billion dollars, but only really faced a several million dollar loss should the bet have failed.

A more technical definition to your question is that with the rise of statistical arbitrage and algorithmic trading, many investment firms act as de facto market makers (making money, more or less, on the bid spread). It has the effect of reducing volatility by adding liquidity to the markets. I won't go into a discussion about long-term stability of such a system, but that is what is happening in essence.
posted by geoff. at 12:24 PM on December 25, 2007

The book I always recommend when this subject is brought up is Despite Good Intentions: Why Development Assistance to the Third World Has Failed by Thomas W. Dichter. There's a chapter that talks about microfinance.

I think that microfinance is helpful because basically it is giving money in the hands of the poor directly, but forcing them to pay back regularly means they have to figure out how to use that money responsibly. The fact that microlending has a good repayment rate suggests that at least it's not throwing money away, although I suspect many in the program are really using the money to make purchases in the same way that we'd use a credit card. It allows them to make large scale purchases that they can then pay back in installments. It isn't always about starting a new business.

I sincerely hope that if and when the kind of commercial bank financing we enjoy makes it to the developing world, it will work with rather than against the existing models.

Related to the OP: don't forget that if you're "purchasing" these loans in GBP, then your credit card will be charged a foreign transaction fee of 2%. So that offsets some of the gains (and compounds potential losses) that would come from exchange rate changes.
posted by Deathalicious at 12:46 PM on December 25, 2007

if you're "purchasing" these loans in GBP, then your credit card will be charged a foreign transaction fee of 2%

Or more, or less, depending on bank. I think HSBC UK charges me 2.75% if I'm stupid enough to use their credit card to buy something in USD.
posted by grouse at 12:50 PM on December 25, 2007

As to your second question, see The Law of One Price, as interest rates are essentially the "price" of money.
posted by Frank Grimes at 1:36 PM on December 25, 2007

Scarabic, that's off-topic, and not terribly well informed.

See the early controversy between rhizome and ssg about whether or not there is interest paid. I think it's exactly on-topic to post FAQs from Kiva that answer that question conclusively for the OP. As for not informed... I think I hit all their FAQs on the subject and posted from the horse's mouth. If you don't like my commentary on the subject, just say that.
posted by scarabic at 3:02 PM on December 25, 2007 [2 favorites]

scarabic: 21% might sound high to you, but it's a rate welcomed by people who are used to being charged 600% -- you can learn more about the poverty premium in C. K. Prahalad's Bottom of the Pyramid
posted by fourstar at 5:17 PM on December 25, 2007

the pound went up, that's all.
posted by thinkingwoman at 5:37 PM on December 25, 2007

scarabic: It should be noted that Kiva will show you the inflation rate that the foreign lender charges. So if someone felt strongly about it they could wait around for opportunities in say, Togo, where they charge 1% interest. Although the inflation rate of a country and the rate normally available to the people are also good things to keep in mind.
posted by Gary at 1:12 PM on December 26, 2007

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