Golden Island is a country flourishing with tourism and it has huge deposits of precious commodities (pearls, corals, and so forth). Its currency is called the Sona (Sn) and its current exchange rate is Sn8.5/$US. The island is governed by a Governor General, a parliamentary body of elected legislators and a couple of agencies to regulate the island’s major industries: pearls and tourism. The country, however, does not have its own economic team and there is no officially published economic data and other information. Economists regularly vacationing on the island serve as independent consultants to the government, and private firms having ties to the island nations also provide advice to the government. The economists and the private firms compile data, track economic performance, and publish newsletters relating to Golden Island. Tirumala Gopal is one such economists and he publishes a monthly newsletter titles, “EcoWisdom.”

Gopal’s EcoWisdom starts with an assessment of the country’s balance of payments. He states, “Base on the data in Exhibit 1, I conclude that from March to June 2011, Golden Island’s:

1.Current account has improved.

2.Financial account has deteriorated.

3.Official reserves position has improved.”Exhibit 1Select Data from Golden Island’s Current and Capital Accounts

　Sona (Sn) in millions 　Quarter ending March 2011Quarter ending June 2011 Exports of goods and services150160 Imports goods and services130170 Net foreign direct investment abroad200230 Net portfolio investment in Golden Island250200 Net interest income1512 Net banking flows(50)15 Current transfers(10)10 In the next segment of EcoWisdom, Gopal argues that the market for pearls does not follow the purchasing power parity (PPP) relation. In support of his contention, Gopal selects Golden Island’s finest quality (AAA rated) Akoya natural sea-pearls, which are prized for their large size, smoothness, round shape and luster. In support of his arguments, Gopal includes Exhibit 2 in the newsletter which contains the price comparisons of a dingle AAA 8-9 mm natural Akoya pearl in five countries including Golden Island, the current spot rates per U.S. dollar, the 1-year interest rates, and the 1-year inflation rates.Exhibit 2Price Comparisons of Akoya pearls, and Exchange, Interest, and Inflation Rates

　Price of on AAA Akoya pearlCurrent Spot Rate: Local currency/$US1-year Interest rate (%)1-year Inflation rate (%) 　In local currencyIn U.S. Dollars Golden IslandSona 400$47.06 Japan￥4,900$57.3485.453.001.20 ChinaYuan 400$61.166.549.505.50 United Kingdom￡32$51.610.624.051.60 United States$55$55.003.501.30 Specifically, Gopal Writes, “From the fundamental value relative to the U.S. dollar based on the absolute purchasing power parity (PPP) using the data in Exhibit 2, I strongly believe that:

1.The absolute PPP holds better in Japan than in other countries examined.

2.Golden Island’s Sona is overvalued whereas the Chinese Yuan is undervalued.

3.The price in local currency in the United Kingdom would have to come down in order for its currency to be fairly valued according to the absolute PPP.”

In Page 2 of EcoWisdom, Gopal assesses the relative PPP of currencies (treating the U.S. dollar as the domestic currency) and makes the following three predictions. Over the next one-year period:

1.Japan’s currency will depreciate.

2.Golden Island’s currency will appreciate.

3.The U.K. currency will have about the same exchange value.

In page 3 of EcoWisdom, Gopal examines uncovered interest rate parity (IRP) relations for the currencies (treating the U.S. dollar as the domestic currency) and makes the following three predictions. Based on a one-year forecasting period:

1.The U.K. currency’s forward rate will equal the current spot rate.

2.The Japanese currency is showing a forward discount.

3.The Chinese currency is showing a forward premium.

In the last page of EcoWisdom, Gopal provides a discount expressing his views and opinions on economic growth and industry regulation. The related excerpts from the newsletter are provided below:

Economic Growth

“Golden Island continues to be heavily labor dependent in its production and processing processes. The country’s real GDP will continue to lag behind other rations unless it achieves productivity gains through technological advances and higher labor productivity. The resulting higher level of income dampens both the birth and the death rate thereby decoupling economic growth from population growth. Golden Island can certainly prove to the modern-day Malthusians that they are wrong.”

Industry Regulation

“It is unfortunate that the country’s regulators have failed to establish an effective government agency to regulate the pearls industry. At present, government regulators appear to be little more than the puppets of the Golden Island Pearls Producers Association (GIPPA), a self-governing industry voice. The government agency has repeatedly sided with GIPPA’s arguments that the quality assurances and ratings currently in force are sufficient. This level of regulation (more correctly, non-regulation) serves GIPPA’s purposes quite well. However, the current state of affairs fails to address numerous concerns expressed by legislators and consumers. One possible explanation for this lax regulation may be found in the fact that several former government regulators are currently serving as consultants for GIPPA.”