Thursday, October 22, 2009

Defensive Investing: Preparing for a currency war

Many people have been talking about how low interest rates and stimulus will devalue the USD. It is more interesting to talk about how long the Fed will apply pressure to the value of the USD and what to do about it.

Historical analysis that says that the Fed usually keeps rates low until 1 year after the peak of unemployment. Since we have not hit the peak of unemployment yet and do not expect it to occur until the beginning of 2010, the Fed will flood us with money until 2011. The USD has already lost 20% of it's value, and could lose another 10-20% more value in the next year.

But the economic policymakers outside the US are not naive. A low USD is like a tariff on imports for America. They know this and like to counteract the problem. On Tuesday Brazil put a 2% tax on all foreign investment into their country to devalue THEIR currency against all other currencies. The next day Turkey announced a similar proposal. Southeast Asian countries (Thailand, Indonesia, Hong Kong, Singapore, Malaysia) have started buying the USD to try to devalue their own currencies against the USD.

So what are we seeing, no one is going to take this lying down. It will turn into a currency war, with everyone racing to the bottom. Southeast Asia and Brazil can put in counter measures, but that only slows the progress. The USD will devalue, but at what price? The US has the biggest pump to flood the world with money, but it does not mean we will benefit the most from the flooding? Likely, but not necessarily.

What to do?: 100% of the known readers of this blog receive income in USD, have debt denominated in USD (if they have debt), and have over 90% of their available cash denominated in USD. A little diversity is a nice defensive measure and never hurt anyone.

As the USD devalues, emerging market currencies become more expensive and stocks in emerging markets equity prices rise. But in this environment owning equities is just like owning a lottery ticket. I think owning emerging market bond fund (EMB) or government debt of other countries (IGOV) in very small portion for a buy and hold scenario is a good step hedging step. Even better is just getting a CD denominated in currency in countries with 1) manageable deficits or no deficit 2) commodity exposure that is an Achilles heal to a devaluing USD (i.e. oil). Two safe choices for the next couple of years will be CDs denominated in the Brazilian Real or the Norwegian krone. Offered at with a minimum $10,000 deposit per CD, the CDs can be rolled every 3 months. The annual interest rate is 4.5% for the Brazilian real and .25% for Norwegian Krone. The money will be there and protected from the degradation of USD and is FDIC insured to boot.

Author recommends opening one rolling 3-month CD denominated in Brazilian Real and 3-month CD denominated in Norwegian Krone.


Lockstep said...

NOR started at 5.63 per USD, now 6.53 per USD. Down close to 20%.

BRL started at 1.73 per USD, now 1.86 per USD. Down close to 10%.

I think I got caught up in the stimulus on this one. I will close the trades at these prices at the 6 month marker.

Lockstep said...

The NOR has recovered to 6.25 per USD. Still down 11%.

The BRL has recovered to 1.76 per USD. Down only 1.7%.

Not as bad as my first investment. I think i will stick with the position based on China continuing voracious consumption of commodities with their continuation of their stimulus measures. Moderation of stimulus in the US will occur sooner. I expect that the US will downturn sooner and thus commodity sellers should continue to strengthen against the USD during this time.

Lockstep said...

Closing the NOR position at 5.50 for a 2% gain.

Lockstep said...

Closing the BRL position at 1.61 per USD for a 7% gain.


Another day another currency war.