Waiting for the pass-through

There are two list prices of my copy of Freakonomics: $C 34.95 and $US 25.95. Yesterday's closing CAD-USD exchange rate was 0.8642. This means that that if you had $C 30,000 handy, you could exchange that for $US 26,000, drive across the border, buy 1000 copies of Freakonomics, cross back again and sell them for $C 35,000, for a tidy profit of $C 5,000. A 17% rate of return on a cross-border round trip sounds like an awfully good deal, and one of the mysteries facing economists is why so many people ignore that bundle of cash on the sidewalk.

The obvious answer is that people can't be bothered: it's a lot of trouble, you don't know how customs officials will react to a cartload of books in your trunk (yes, I know there's supposed to be free trade between the US and Canada, but it never seems to apply where it might be useful), and how are you going to unload 1,000 copies of Freakonomics at list price?

But what if you shop on-line? You don't have to travel, and you don't have to pay list price, either (Perhaps books should come with the consumer protection disclaimer that Dave Barry once suggested for automobiles' list prices: 'Warning for stupid people: Do not pay this price.'). You'd think that the internet would provide a level playing field, but while the Amazon.com price for Freakonomics is $US 15.57, the Amazon.ca price is $C 20.97. The rate of return on pure arbitrage - buying a good in one market and selling it in another - is still 16%.

If you look at a graph of import prices and the USD-CAD exchange rate, it looks as though the stronger CAD has indeed been reflected in import prices:

Up until recently, movements in the exchange rate more or less showed up in import prices. But it turns out that this is an artifact of how the data were constructed: in this recent Board of Governors working paper (pdf), the authors note that exchange rates are used in the construction of import price data. The rate at which consumer prices in Canada adjust to exchange rate movements appears to vary between 'extremely slow' and 'glacial'.

Of course, it works in both directions as well. In the last decade, no-one seemed to complain too much about the fact that consumer prices weren't rising as the CAD was falling.

Comments

[Phil]

I just returned from a trip to the US, and noticed the same thing -- but just on books. There were few, if any, bargains to be had otherwise. The prices I saw on other products were usually worse than Canadian prices (after adjusting for the exchange rate).

So I wonder if this arbitrage opportunity only exists for books. Books are unusual in that they're almost the only product where prices in both $CAN and $US are printed directly on the item. (Apart from the exchange rate anomaly, why is that?)

Perhaps the reason for the discrepancy is that stores can easily charge less than cover price, but not more. Since a book could easily sit on the shelves for a couple of years, better to protect against the exchange rate moving by asking a high exchange rate and then letting the Canadian store discount as appropriate.

Not a very plausible theory, but the only one I can think of. If it's correct, we should see the spread narrow over the next few years if the exchange rate stays low.

Professor Gordon, are you saying that there are other products than books for which a high implied exchange rate applies? What are they?

[Stephen Gordon]

The only first-hand information I have is my sabbatical in San Diego in 1999, a couple of years before the CAD started its rise. Our first trip to the grocery store was a shock: everything was the roughly same price as back home, but in USD. Ouch.

It may well be that the rise in the CAD since then has erased this gap. The point is that the movements in exchange rates take forever to show up in consumer prices.

[happyjuggler0]

I'm willing to bet a bunch of money you can get a better discount than 16 or 17% for 1000 books if you buy from the publisher directly. I suspect a 50% or so discount is a better neighborhood.