What are the economics of black market money exchanges?

Question

It's fairly well know that if you are in a country with a "problematic" economy, that exchanging money on the black market can get you a much better rate than at an official exchange.

But how do these money changes make a profit? They need both a source of local currency to supply their customers, and a means of turning the foreign currency into something usable by them.

But if you can only get local currency from official sources at a lower rate, how do the money changes obtain it at a rate that makes sense to them?

And what do they do with the foreign currency?

I am wondering if at some level the profitability of these exchanges are based on illegal markets such as commercial drug smuggling (or something else).

Does anyone know of any studies that show the economic underpinnings of black market money changers?

Answer 1

A few months ago I was in Argentina where this is a fact of life. On the street you can easily exchange Dollars into Argentinian Pesos at the "blue rate" which is about twice the official rate.

It does not seem to be illegal, at least there is no enforcement and on Calle Florida in Buenos Aires police officers and money exchangers are happily chatting away while attending to their respective business.

The driving factor here is that Argentina has rampant inflation. Hence most Argentinians want to turn the their Peso into dollars as quickly as possible. Since the government has severely limited the amount you can exchange at the official rate at a bank a "free market" for dollars has popped up. Argentinians want to buy dollars and so the rate is a matter of negotiation between the buyer and the seller as it would be for a shirt or a knickknack in the gift store.

It appears that larger purchases are quoted and negotiated in dollars. For example the price for real estate is always quoted and negotiated in dollar. I don't know how the actual payment works but in Argentina US cash is king, simply because it's much more stable than the local currency.

In that sense the money exchangers are really just brokers: they buy US$ from tourists and resell them at a profit to interested citizens. The average Argentinian doesn't have time or interest in standing on the a street all day yelling "Cambio, Cambio". That's the job the money changers get paid for. No drugs or other illegal activities involved.

Answer 2

The 'black' exchanges depend on official exchanges which offer unreasonable prices in one direction and cannot fill all demand in the other direction.

Consider the situation between the German Democratic Republic, GDR, (which was the communist part of Germany during the the Cold War), and the Federal Republic of Germany, FRG, (the western part). The GDR had the Ostmark (Mark of the GDR), the FRG had the Deutschmark (German Mark). During the last years of the GDR, the official rate of Deutschmark to Ostmark for visitors was 1-1. Black market rates were around 1-5 to 1-10. That means:

• GDR citizens visiting the FRG could officially exchange 15 Ostmark for 15 Deutschmark. They could not easily exchange more at the official rate.
• FRG citizens visiting the GDR had to officially exchange 25 Deutschmark for 25 Ostmark per day. They were free to exchange more, but why should they? (See below.)
• GDR citizens could buy Deutschmark at the black market rate, which was considerably higher than the official rate. They did it because that was the only way to get more Deutschmark, if they dared to break GDR law.
• FRG citizens could buy Ostmark at the black market rate, which was considerably lower than the official rate. They did it because they got more Ostmark for their Deutschmark that way, if they dared to break GDR law.

Much of the black market exchanges were so informal that there was no real consideration of 'transaction fees' to fund the exchange. But people who wanted to earn money on the black market would try to buy low, sell high, in either direction.

Answer 3

Your premise is flawed. Black market exchanges don't get the local currency from official sources. They get it from locals who want to convert local currency to foreign currency (often US dollars,) as a hedge against devaluation. Locals will also convert the other way when they need to spend their dollars in the local currency.

A functional market balances supply and demand, and black market currency exchanges are no different; if there's not a enough supply of local currency the exchange rate will change until there is (and the same is true if the imbalance is in the other direction.)

Answer 4

Black market money changers (when legitimate, sometimes they are just thieves) are middlemen.

Say the rate between Euros and Blokniks is officially 1:1 but most locals can't get Blokniks because the currency is not freely traded- there are capital controls, currency controls etc. The tourist who pays for official things must pay 10 Euros for something priced at 10 Blokniks (for example, a hotel room where that is controlled by the government).

A local may need Euros for some reason that does not concern us here. For example, they may need Euros to apply for a school overseas. But they only have their local currency. Banks won't help them.

So they go to the black market and buy (say) 100 Euro for 1000 Blokniks. Where do the Euros come from? The middleman will pay (say) 500 Blokniks for 100 Euros to a tourist. Their profit is thus 500 Blokniks. The tourist can buy a dinner at a restaurant for 1/5 of what they would otherwise pay.

Of course this is typically breaking the law so it entails some risk.

Sometimes the black market ratio is much less, 10 or 20% , but the 10:1 was literally the difference for East German marks at one point. And 100 marks would easily fit in a sock.

Answer 5

I'm from Buenos Aires, Argentina.

In Argentina, dollar is used as a medium of savings, both because of idiosincrasy and because currency devaluates too fast and rates usually doesn't overcome that, or it is to risky to put money at fixed-term deposit. Black money exchange (which we epuphemistically call "blue") obtains his profit by charging a spread of course.

The source of local currency is people in search of savings, exchanging to buy real estate (such opeations are in USD) or for travel. The source of foreign currency is usually from people who need local currency to pay wages and is in need to leave some "savings" (It should be noted that there are significative unregistered job rates).

Thus, it's the same money circulating.

But, it would also be noted that aside of black market there is a "grey" market that is legal, which operates in stock exchange market (bolsa de buenos aires) in which bond titles can be freely purchased or selled both in local and foreign currency (USD). From these operation arises an implicit exchange rate, which has a similar gap with respect of the official rates that black market (sometimes higher, sometimes lower)

Again, this market need no dollar sources since it is operated between privates, However there is some degree of government intervention at cost of treasure USD to prevent that implicit rate go too high. These money is depositated in USD accounts of those who buy debt titles in local currency and sell in foreign currency at implicit rate.

This is also a source of foreign currency for the black market.

See yourself: https://dolarhoy.com/ https://www.valordolarblue.com.ar/

Answer 6

The other answers are giving very good examples. However, in some "black" currency markets part of the economy is that the buyer gets less money than he thinks he gets. I.e. some bank notes are forged or even just photocopies or colored slips of paper.

Answer 7

If the value of a country's currency falls then imports get more expensive and exports get cheaper. If the value of a country's currency rises then imports get cheaper and exports get more expensive. Either of these changes can be problematic.

Hence governments manipulate their exchange rates. The most obvious way to do this is by participating in the currency exchange market themselves, buying or selling foreign currency to manipulate the price. However this technique has it's limits, a government can print and sell unlimited amounts of their own currency, but they can't sell foreign currency they don't have.

So what is a country who wants to preserve the value of their currency, but has dwindling foreign currency reserves to do? one option is to restrict who can buy foreign currency and in what amounts!

It is those restrictions which drive the rise of a black market. People want more foreign currency than the government will let them buy, either because they want to spend it abroad or because they don't trust the government not to destroy their capital with inflation*.

* Yes inflation happens in major world currencies like the Dollar, Pound and Euro but typically not at anything like the rate it can happen in failing economies.