Saturday, October 4, 2014

Stock as a medium of exchange

American Depository Receipt (ADR) for Sony Corp

You've heard the story before. It goes something like this. There's one unique good in this world that serves as a universal vehicle by which we conduct every one of our economic transactions. We call this good "money". Quarrels often start over what items get lumped together as money, but paper currency and deposits usually make the grade. If we want to convert the things that we've produced into desirable consumption goods (or long-term savings vehicles like stocks), we need to pass through this intervening "money" medium to get there.

This of course is fiction—there never has been an item that served as a universal medium of exchange. Rather, all valuable things serve to some degree or other as a medium of exchange; or, put differently, everything is money. What follows are several examples illustrating this idea. Rather than using currency/deposits as the intervening medium to get to their desired final resting point, the people in these examples are using a non-standard intervening media—specifically, listed equities—in order to move from an undesired currency to a preferred currency.

Zimbabwe and Old Mutual

In the midst of the Zimbabwe hyperinflation I began to toy with the idea of purchasing Zimbabwean stocks. The market value of the entire Zimbabwe Stock Exchange had collapsed to a fraction of its Zambian and Botswanan peers, and picking up a few bellwether names might provide some value, went my thinking. The difficult part was buying the Zimbabwean dollars necessary to build my position. Selling my Royal Bank deposits (I live in Canada) for deposits at a bank in Zimbabwe, say Barclay's Bank Zimbabwe, would not only take a long time to complete, but I'd end up having to pay the official rate for Zimbabwe dollars, which was far below the market rate. The losses on this forex conversion would destroy any opportunity for a profit on the shares.

There was an alternative route. I could sell my Royal Bank deposits for shares in a firm called Old Mutual, listed on the London Stock Exchange. The kicker is that Old Mutual had (and continues to have) a listing on the Zimbabwe Stock Exchange. Using a stockbroker in Zimbabwe I could have transferred my London-listed shares to the Zimbabwe Stock Exchange, sold the shares, leaving Zimbabwe dollars in my brokerage account. Since the ratio of Old Mutual in London and Zimbabwe was free to fluctuate (unlike the official exchange rate), I'd effectively be purchasing Zimbabwe dollars at the correct market rate, not the overvalued official rate.

Next I could have used my Zim dollars to buy the Zimbabwe-listed stocks that I wanted. When the time came to get out, I could have sold my shares for Zimbabwe dollars, repurchased Zimbabwe-listed Old Mutual shares, had my broker 'uplift' those shares over to the London stock exchange upon which I would once again sell Old Mutual for British pounds, eventually ending up with my Bank of Montreal deposits.

What an incredible chain of transactions! Which explains in part why I chickened out. Nevertheless, the example illustrates the necessity of having an appropriate and non-standard "medium of exchange", in this case Old Mutual, in order to shift from one brand of "money" deposits to another to another.

ADRs and the Argentinean Corralito

A similar example played out during the Argentinean corralito of late 2001 and early 2002. In early December 2001, in an effort to prevent massive capital outflows, Argentinean authorities established financial controls which, among other restrictions, imposed a ceiling of $1,000 a month on bank withdrawals. This became known as the corralito, the diminutive of corral, or animal pen. With a devaluation imminent, and even worse, pesofication—the forced conversion of bank deposits from USD into pesos—Argentineans could only sit helplessly as their frozen deposits awaited their doom.

Argentineans quickly found a way to evade the corralito. While they could only withdraw limited amounts of dollars from their bank accounts, they were allowed to buy any amount of stocks listed on the Buenos Aires stock exchange. Since stocks would be protected from the ensuing devaluation and pesofication, a mad rush into the markets ensued along with a terrific rise in share prices.

Snipped from Auguste et al, 2005.

What is interesting is that certain Buenos Aires-listed stocks were adopted as a convenient medium for escaping Argentina altogether. Here's how. An asset class called the American Depository Receipt, or ADR, trades on the New York Stock Exchange. ADRs are market-listed securities that represent an underlying batch of non-US shares. The way an ADR works is that a U.S. custodian bank will issue an ADR to an investor after the underlying shares having been deposited in a foreign depository bank where they will be held for safekeeping. An owner of ADRs enjoys all the economic rights (dividends, votes, capital appreciation) as the underlying shares held in deposit.

A number of Argentinean names traded on ADR form in New York, including a Banco Frances ADR and a Telecom Argentina ADR. During the corralito, an Argentinean could buy an Argentinean stock that traded on the Buenos Aires Stock Exchange, say Telecom Argentina, and immediately deposit these shares with a local depository. The shares having been deposited, a U.S. custodian bank would create an overlying ADR for the Argentinean investor. Since these ADRs were traded in New York, the Argentinean could turn around and sell the ADR for U.S. dollar deposits. Telecom Argentina shares and its linked ADR had become a medium of exchange of sorts, allowing Argentinean investors to convert from one brand of money, pesos, into another, US dollars.

Canada: Norbert's Gambit

Nor is the use of equity as a medium of exchange solely a phenomenon of crisis economies like Zimbabwe and Argentina. Enter Norbert's gambit. The name comes from Norbert Schlenker, an investment advisor in B.C. who popularized the technique. Canadian discount brokerages charge around 1.5% on forex conversions, which is a lot. Norbert's Gambit is a cheaper way to convert Canadian dollars to U.S. dollars and back.

The gambit works this way. Horizons US Dollar Currency ETF, which holds very short term US debt, trades on the Toronto Stock Exchange in US dollars under the ticker DLR.U as well as the ticker DLR, which is quoted in Canadian dollars. Investors can spend Canadian dollars in their brokerage account to buy DLR, convert those units to DLR.U, and then sell those DLR.U units for US dollar deposits. Voila, they've used an ETF as a medium to move from one "money" to another.

Interlisted stocks like Royal Bank or Potash Corp, which trade on both the Toronto and New York markets, can also be mobilized for Norbert's Gambit.


Norbert's Gambit, the Old Mutual switch, and the Argentinean ADR evasion are only a few examples of things that we normally don't consider to be "money" being mobilized as media of exchange. But these three are just the tip of the iceberg. Consider the fact that everyone who acts as a dealer in goods or securities is using these items as an exchange medium. Just as someone builds up a stock of cash for eventual future exchange, a t-shirt dealer purchases an inventory of t-shirts for future sale.

It's not just t-shirts. Every dealer from the gas utility to the car lot owner to a market maker in a small cap stocks uses the particular good in which they specialize—natural gas, cars, and penny stocks—as their medium of exchange. Some media are more general than others and will tend to appear in a larger proportion of transactions, but this doesn't make them qualitatively different from those that are less general. Put differently, there is no such thing as a valuable good that does not function as a medium of exchange: rather, there are only good media of exchange or bad ones.


There is a body of academic work on the Argentinean corralito, stock prices, and ADRs

1. Melvin, 2002., A Stock Market Boom During a Financial Crisis: ADRs and Capital Outflows in Argentina
2. Yeyati, Schmukler, & Van Horen, 2003. The price of inconvertible deposits, the stock market boom during the Argentine crisis.
3. Auguste et al, 2005. Cross-Border Trading as a Mechanism for Implicit Capital Flight: ADRs and the Argentine Crisis.
4. Brechner, 2005. Capital Restrictions as an Explanation of Stock Price Distortions During Argentine Financial Collapse: December 2001 – March 2002.
5. Lam, 2011. New Evidence on the Wealth Transfer during the Argentine Crisis.

No work has been done on Old Mutual and the Zimbabwean hyperinflation.


  1. Suppose there is a monetary exchange economy, but the dollar price of apples, and the dollar price of bananas, are both fixed too high, so there is an excess supply of apples in the apple/dollar market, and an excess supply of bananas in the banana/dollar market.

    That creates an incentive for people to barter apples for bananas, even though barter is less convenient than monetary exchange.

    The unemployed hairdresser cuts the hair of the unemployed masseuse, in exchange for a massage. Because there is an excess demand for money.

    1. "Suppose there is a monetary exchange economy."

      I'm not sure what that means.

    2. It means that all other goods are traded for one good, and only one good. We call that one good "the medium of exchange".

      Being a monetary exchange economy is an endogenous attribute of an economy. In some cases, like the imposition of price controls, a monetary exchange economy will stop being a monetary exchange economy. We will observe some trading between two of the other goods.

    3. In the real world, almost nothing is pure. Pure monetary exchange economies do not exist in reality. There are always exceptions. But those exceptions, especially if they can be explained, do not invalidate the distinction. A bald man is different from a hairy man, even if he does have a couple of hairs on his head.

    4. To me a monetary economy emerges the moment we begin to move from autarky to trade. Disparate 'tribes' start to accumulate buffer stocks of goods for anticipated trade, and these goods start to gain liquidity premia.

      So an economy has become a monetary economy long before it arrives at a state at which all other goods are traded for one good, and only one good.

  2. Barter is when you swap one thing of narrow transaction utility (useful only for a few transactions) for another thing of narrow transaction utility. The point of a medium of exchange is that it has broad transaction utility (i.e. is useful for lots of transactions). Now, there is a "how broad is broad" issue, but a medium of exchange has to be something that people actually hold to use in other transactions--i.e. it has to be a transaction good. Merely being used in transactions does not make something a transaction good; merely being used in exchange does not make something a medium of exchange.

    1. "Barter is when you swap one thing of narrow transaction utility (useful only for a few transactions) for another thing of narrow transaction utility."

      So what is it called if you and me were to swap one thing of narrow transaction utility -- Botswanan Pula -- for something with equally low transaction utility -- Angolan kwanzas? Barter?

      What do you call it when someone swaps one thing with high transaction utility -- US Treasury bills -- for another thing with high transaction utility -- US treasury bonds?

      What do you call it when I swapped Ripple for bitcoin?

      Barter vs non-barter transactions, I don't see this as being a meaningful distinction. About all we can do is shift towards goods with poorer liquidity, equal liquidity, or superior liquidity.