Okay, suppose you are a hedge fund manager with a billion dollars to invest globally.
Your specialty is using so-called,
Exchange Traded Funds or ETFs to invest in specific countries,
based on opportunity and risk.
And here note this key definition of an exchange traded fund.
An ETF, or Exchange Traded Fund,
typically tracks an index,
like the S&P 500 stock market index.
A commodity such as oil,
long or short term bond portfolios and other assets like real estate.
The beauty of Exchange Traded Funds or ETFs,
is that they can be traded just like stocks.
And there are ETFs you can invest in for stock markets of countries around the world,
from Germany and Great Britain to China,
Japan and even New Zealand.
Suppose that you in your role as a hedge fund manager,
read in the news that in response to a steep and prolonged recession,
the American government and its central bank of
the Federal Reserve embarks on an aggressive policy of Quantitative Easing.
And note that Quantitative Easing is a form of monetary policy
that involves buying long term government bonds with newly printed money.
Of course, the goal of Quantitative Easing is to
drive down long term interest rates to stimulate growth.
Here's what I call the money question.
Would you as a hedge fund manager,
be more or less inclined to invest in New Zealand for
your hedge fund portfolio once the U.S.
Federal Reserve begins its aggressive policy of quantitative easing?
And note that in thinking about your answer,
New Zealand is a country that depends heavily on exports,
in its GDP equation for its growth.
So do think about this intriguing money question for a minute,
which may seem a bit strange at first,
but then jot down your answer before moving on.
In fact, this question is not strange at all,
just a bit complicated in a fun kind of way.
And the answer is this,
as a hedge fund manager you should definitely not
buy the New Zealand Exchange Traded Fund.
Here's why and see if this is the same answer that you get.
If America embarks on a policy of loose monetary policy,
this will drive down U.S. interest rates on long term bonds.
Lower American interest rates will in turn drive down the value of
the U.S. dollar relative to other currencies like New Zealand's dollar.
And note that the US dollar will fall because of fall in interest rates and America,
will make foreign investment in the US less attractive,
so there will be less demand for dollars.
As for the rise in New Zealand's exchange rate,
a stronger currency will make it harder for
New Zealand dairy farmers to sell their exports.
The result will be a fall in net exports as
indicated by an inward shift of New Zealand's aggregate demand curve.
Of course, this causes a fall in
real GDP and with lower profits in the New Zealand economy,
New Zealand's stock market falls along with the New Zealand ETF.
You definitely don't want to be investing in
New Zealand in this quantitative easing scenario.
So take a minute now to study this figure very carefully and be
sure you understand every single step along the way.
When you are finished, let's move on to the next and final module of this lesson.
