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 Everbank.com 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.

Emerging Markets: More in line with the US market than first meets the eye

I buy into the idea that the greatest opportunity for growth in the future will be outside the US. Even more immediately, I will show in this post that the decline of the dollar will make smart emerging market investments even more attractive in the coming deflationary correction.

For example, let's refer to recent history regarding the behavior of the market during the crisis days of Nov 2008. At that time there was a tremendous flight to the USD dollar as investors sought safe investments during the crisis. During that time, the Brazilian Real lost 50% of it's value due to declining commodity purchases and concerns over the world economy.

One of the investments I find attractive in South America is Brazilian bank Banco Bradesco (BBD). I expect that banks will profit from the emergence of a new middle class in Brazil. BBD was trading at $10 in November. As of today the stock closed at $21.50, clearly outpacing the market as a whole. But this is not so simple, because since November the Brazilian Real has recovered 40%, the stock has only appreciated 60% in local currency. This only slightly outperforms the 53% returns of the S&P 500 index from March 2009 bottom. This is occurring not just for Brazil, but for Mexico and many other markets where currency appreciation has occurred against the USD. Many investment magazines and pundits have been pumping emerging markets as outperforming the US. Actually, performance is equivalent, it is just the currency basis that provides the advantage.


What do we gain from this observation?



1) When panic strikes, and there is a flight to the USD, emerging market companies become very cheap

2) If the US, in response to a panic, uses easing methods to address the downturn, this is bullish to US investors interested emerging market stocks simply because of the basis risk (or in this case reward) from monetary easing and a devaluing USD.

I have no positions to recommend at this time. But it is easy to foresee another stage in the crisis due to deflation that is addressed once again with huge floods of dollars. At that point, it will be important to recognize this pattern and take positions in companies like BBD, CETV, TLK, SBS, and GMK to reap benefits from this occasion.

The whole world is on Viagra

Last night I heard a story about a friend who looks after his 91 year old grandfather. My friend has a dilemma that even though his grandfather's health is failing because his advanced years, he continues to live the lifestyle of someone younger and more spry. In fact on more than one occasion he has found his dear old grandpa passed out in various areas of the house from overdoses of Viagra.

The global economy is experiencing a similar circumstance.

With US port traffic down...

Retail sales down...


imports and exports are down...


There is little sign of virility to the economic situation. Yet the global markets stay excited over the prospects of a turnaround in the face of this information. Why?

Artificial stimulation from bailouts and stimulus plans, of course.

Only $230B of the $787B US stimulus package has been spent to date. But US is far along ($700B) with the housing market stimulus executed with the 1.25T allocation to purchase agency debt. The US is also stimulating the housing market with $500B in purchases of securitized mortgage debt in the open market at exaggerated prices. Without this support, mortgage rates would rise and provide an additional disincentive for the anemic rate of home sales.

There are auto purchasing incentive programs in the US, South Korea, China, and Brazil. The U.S. , the last to adopt an auto purchase incentive program, "Cars for Clunkers" program has been expended from $1B to $3B in funding. The government rebate will be used in an estimated 500,000 car transactions this year in the US. It has been shown before that such stimulus only pulls forward future purchases. Maybe this time will be different...

In the U.K. the government continues to use quantitative easing to support the yield curve and keep mortgage rates down. The U.K. recently extended their quantitive easing program by authorizing another $50B in funds to attempt artificially depress interest rates.

China also is in the process of executing a $586B spending package to maintain economic growth. But this pales in comparison to the loose monetary policy underwritten by the Chinese government. In the first half of 2009, over a $1T in loans has been made, a 1000% increase over the previous year.

The overall stimulus in China has been massive. “They opted for a very quick fix,” said Stephen Roach, an economist and chairman of Morgan Stanley Asia. “Surging investment, fueled by the most rapid bank lending in history, accounted for nearly 90 percent of China’s G.D.P. growth in the first half of this year. And that is worrisome.”

Overall, with Japan, France, Germany, China and soon the US reporting Q3 growth and no top line growth across the whole bunch, it looks like ailing economy is dependent on special pills to stay in the game. Let's hope we don't over exert ourselves in the process.