Doing direct comparisons of price levels in any country is really an exercise of little value. Consumer goods in Cuba are expensive to Cubans, but the same items in Japan (at a higher price in any currency) are cheap to the Japanese. How can this be? What we can afford to pay for goods is a function of what we earn. What we can spend is after tax has been deducted and other essential needs have been paid for. In a country like the UK you don’t spend as much money on healthcare and safety as in other countries. Those items are already included in the taxes paid. Taxes are surprisingly low in the UK, but that is slowly changing.
So how do we make a meaningful comparison? The only item everyone worldwide has the same amount of, is time. Consider “time” to be a universal currency. Thus a good measure of affordability is how long it will take you to earn the same item. (The fact that items vary in quality and need replacing more often in some countries will be ignored for now). Calculations for your doing the same job in the UK is obviously necessary to conduct a meaningful review, so see the chapter on employment.
In the meantime we will use average earnings to explain affordability further. The UK has amongst the world’s most even distribution of wealth. The “average” person exists in tens of millions in the UK. The average working person in the UK earns £23,000 a year. The tax take on this is about 25%. Worked out on an hourly basis (52 weeks and 35 hours a week) this equates to netting just over £9 an hour.
Going down to your local hamburger outlet in London and having a meal comes to, for simplicity sake, £4. That is less than half an hour’s net income. For someone from Madagascar, that meal is almost the equivalent of a week of working. The Briton will tell you the meal is affordable (or even cheap) whilst the person from Madagascar couldn’t disagree more. The same meal in Madagascar costs the equivalent of £1, but the Madagascan person never buys it because…it’s unaffordable. Get it? Affordability is about how long it takes you to earn after tax what you want (or need) in the area that you spend it.
It is why tourists from around the world find Western Europe an expensive place to visit, because they don’t earn their income there. As an outsider looking in, another economy’s price levels will always look disjointed. It is only when you’re earning your keep in that economy that it will make more sense to you. Keep this measure of affordability in mind when evaluating prices. If you’re able to calculate your own earning power doing a comparable job in the UK, then great. Words of warning though, just don’t count on earning that kind of money from day one in the UK.
2009-5
27
What is “affordable”?
2009-5
19
Laminate flooring at Carpet One
Nowadays, flooring choices might be overwhelming with often hundreds of options to choose from. I decided to change my hardwood floor, which became worn out over time, to something different. I didn’t want the thick 3/4in boards but something lighter and brighter and, most of all, cheaper. I discovered Carpet One, whose advisors pointed me to an excellent deal on laminate flooring. I chose ta Platinum labeled floor, which is one of the most durable in the industry and carries the highest level warranty.
Thank you carpet One. I’m pleased with my choice.
2009-5
12
THE ROLE OF FUTURES MARKETS AND EXCHANGES
Virtually all participants in the financial markets have heard of futures markets, but many do not understand the role that futures markets play. Some participants do not understand how futures markets function in global financial systems and often look at futures with suspicion, if not disdain.
In earlier posts, we discussed the purposes of derivative markets. We found that derivative markets provide price discovery and risk management, make the markets for the underlying assets more efficient, and permit trading at low transaction costs. These characteristics are also associated with futures markets. In fact, price discovery is often cited by others as the primary advantage of futures markets. Yet, all derivative markets provide these benefits. What characteristics do futures markets have that are not provided by comparable markets as forward markets?
First recall that a major distinction between futures and forwards is that futures are standardized instruments. By having an agreed-upon set of homogeneous contracts, futures markets can provide an orderly, liquid market in which traders can open and close positions without having to worry about holding these positions to expiration. Although not all futures contracts have a high degree of liquidity, an open position can nonetheless be closed on the exchange where the contract was initiated.51 More importantly, however, futures contracts are guaranteed against credit losses. If a counterparty defaults, the clearinghouse pays and, as we have emphasized, no clearinghouse has ever defaulted. In this manner, a party can engage in a transaction to lock in a future price or rate without having to worry about the credit quality of the counterparty. Forward contracts are subject to default risk, but of course they offer the advantage of customization, the tailoring of a contract’s terms to meet the needs of the parties involved.
With an open, standardized, and regulated market for futures contracts, their prices can be disseminated to other investors and the general public. Futures prices are closely watched by a vast number of market participants, many trying to discern an indication of the direction of future spot prices and some simply trying to determine what price they could lock in for future purchase or sale of the underlying asset. Although forward prices provide similar information, forward contracts are private transactions and their prices are not publicly reported. Futures markets thus provide transparency to the financial markets. They reveal the prices at which parties contract for future transactions.
Therefore, futures prices contribute an important element to the body of information on which investors make decisions. In addition, they provide opportunities to transact for future purchase or sale of an underlying asset without having to worry about the credit quality of the counterparty.
In earlier posts we studied forward and futures contracts and showed that they have a lot in common. Both are commitments to buy or sell an asset at a future date at a price agreed on today. No money changes hands at the start of either transaction. We learned how to determine appropriate prices and values for these contracts. In future posts, we shall look at a variety of strategies and applications using forward and futures contracts. For now, however, we take a totally different approach and look at contracts that provide not the obligation but rather the right to buy or sell an asset at a later date at a price agreed on today. To obtain such a right, in contrast to agreeing to an obligation, one must pay money at the start.