Protecting yourself against currency crisis

January 29th, 2010

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Today, we will continue from the final question asked at Next phase of GFC is when governments go bust,

When governments go bust, we will have currency crisis. How do you protect yourself against this?

First, let us begin with understanding what a currency crisis is. From the Wikipedia,

A currency crisis, which is also called a balance-of-payments crisis, occurs when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value…? Governments often take on the role of fending off such attacks by satisfying the excess demand for a given currency using the country’s own currency reserves or its foreign reserves (usually in euros, US dollars or UK pounds).

Basically, a currency crisis occurs when there is a problem in a country’s balance of payments (see Understanding the Balance of Payments). The currency will depreciate very rapidly and as a consequence, cannot be used as money and cannot function a store of value effectively. This usually manifests itself as sky-rocketing price inflation, which undermines everyone’s standard of living. When Hugo Chavez recently announced the planned devaluation of the Venezuelan currency (that’s not technically a currency crisis, but this is just an example to show you its effects), people rushed out to buy consumer goods in anticipation of price inflation.

From this, you can see that obviously, the key to protecting yourself from a currency crisis is to diversify your savings away from the affected currency (e.g. foreign currency, gold, silver, etc). Does it mean that all we have to do to hedge ourselves is to go to our local bank branch, open a foreign currency account and then transfer some of our savings to that account?

Unfortunately, that’s true only in a perfect world. In reality, when there’s a currency crisis, there’s a high chance that a banking crisis will come along with it. For example, in Argentina’s currency crisis (1999-2002), the government froze bank accounts in an attempt to prevent a run on the banks. In some cases, governments may even impose capital controls (especially in pegged currencies), which basically means your money will be stuck.

In such an environment, Black Swans abound, which means the financial system may be dysfunctional. That means your foreign currency stored in your local bank’s foreign currency account can be, for all intent and purposes, useless. In today’s modern economies, since exchange of physical cash forms a tiny percentage of commercial transactions, a dysfunctional financial system will affect most commercial transactions in the economy, which in turn implies that the economy will be paralysed. Even if the financial system is working, price inflation will make life miserable for most people.

In such a bleak environment, we can imagine people resorting to barter, physical cash (both foreign and local) and even physical silver and gold. Hopefully, local governments and communities will take the initiative and come up with complementary currencies so that the economy can still function (otherwise, everyone will be reduced to primitive bartering). In Argentina, a spectrum of complementary currencies had emerged, in such a large scale that some of them are even called “quasi-currencies.”

Personally, we feel that the best way to protect yourself from a currency crisis is to leave the country before TSHTF. If not, stock up some physical cash (both foreign and local), physical gold and silver (see our book, How to buy and invest in physical gold and silver) and supplies- these will tide you over while the sh*t is hitting the fan. For the longer term, you may want to move some of your savings overseas- you may not be able to use them in the midst of the crisis, but when it is all over, the local currency may no longer exist (e.g. you may have to convert the old currency to a new one at unfavourable rates).

Note: All these are NOT personal advice- they’re just ideas for you to consider.

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  • Mike Goddard

    What happens to your debts that are denominated in dollars during a crises. ie house loan etc if the dollar crashes do you owe in old dollars or new currency?

  • Anon

    Which direction gents?
    I'm betting down 9000-9800 perhaps. I increased my cash reserves and shorts throughout this correction.
    There seems to be alot of people preaching the 1h recovery, 2h collapse…i think people have it backwards from the economic data I am reading.
    Pete must be salivating at this with his humongous cash pile lol.
    Remember above is not advice, just commentary, go see a financial advisor 😉

  • Anon

    “For the longer term, you may want to move some of your savings overseas- you may not be able to use them in the midst of the crisis, but when it is all over, the local currency may no longer exist (e.g. you may have to convert the old currency to a new one at unfavourable rates).”

    Thanks CIJ. I've already got cash denominated in GBP, USD. The GBP:AUD mispricing is very extreme but its run abit from when I entered near the lows.
    Im short the EURO (against GBP)…that currency is just flawed. How can you save a dead economy if you have no access to QE/money printing. Germany et al cant keep bailing out the dogs forever. I think the EURO is just statistically a bad play. Theres a higher probability one of the PIIGS will fail (as opposed to USA, UK etc) and then it will be utter panic from the political mess you described earlier.
    Remember above is not advice, just commentary, go see a financial advisor 😉

    Heres some stuff I have been reading that might interest someone 😉 —

    http://www.thegatesnotes.com/Thinking/article.a

    http://www.thegatesnotes.com/Thinking/article.a

    http://www.thegatesnotes.com/Thinking/article.a

  • Anon

    test, plz dont post this cheers

  • @Mike

    Chances are borrowers will not be allowed to get away with it unless there's a debt moratorium.

  • Pete

    Yep. Personally I would expect banks to raise interest rates at a minimum to:
    level of inflation + credit cost + profit requirement

    But I am not a bank CFO, nor nostradamus. Personally I would never bet against a bank taking as much as it can.

    …and there is no ceiling to interest rates, unless you fix your loan or the Government makes it legislation as CIJ says.

  • Pete

    Haha Anon, I wish I had that much moolah.

    For someone on zero leverage I do okay for myself, but this year I will (probably) just sit back and accumulate more savings (I liquidated all my shares 2 weeks ago).

    I'm a bit sceptical that this correction will be a lasting one. But you never know. Maybe it will get some momentum and be iGFC 2.O

    Also I agree with your post below about the Euro. Good in theory, but not in a crisis. You never know, maybe the ECB will go QE/Bailout crazy.

    Not directed solely at you Anon, but ironic to say “see a financial advisor” when I suspect most readers here would rather chop off their hands than take advice from someone selling leveraged financial ruin 😉

  • Pete

    I like this article CIJ 🙂

    Personally, we feel that the best way to protect yourself from a currency crisis is to leave the country before TSHTF.

    This has been a longer term plan I have considered for the last year (roughly). I am not in a position to do anything about it yet of course.

    A question I am continually pondering… which countries will be good to migrate to?

    That is a pretty tricky question.

    Because the country would need:
    – decent currency
    – decent standard of living (for softies)
    – decent tax laws
    – decent freedom of speech/expression
    – preferrably low level of corruption
    – convenient migration policies (ive heard some countries are a bit strict)

    I even considered Japan. Unfortunately I think that will fail majorly on the first criteria (and hence criteria 2 aswell).

    Thoughts anyone?

  • Anon

    “Not directed solely at you Anon, but ironic to say “see a financial advisor” when I suspect most readers here would rather chop off their hands than take advice from someone selling leveraged financial ruin ;)”
    Rofl
    I was going to add a disclaimer to the disclaimer but then I reconsidered 😉
    Unfortunately I didn't dump at the top, didn't listen to my intuition and got swept into the crowd. Great timing on your exit.
    Luckily my currency hedges and shorts softened the blow. I'm down 3.8% against the Xao's fall of approx 7% and the DJIA fall of approx 6%. Abit angry I didn't keep positive tbh.

    I guess we could bounce here short term. I suspect there might be a flight to quality if we have any increased volatility. So i've been unloading a few of those hail mary roulette wheel speccies.

    Did you listen to old Billy Gates on the Podcast (links in other post). You fall asleep after about 5 minutes lol.

  • @Pete

    Marc Faber once said that India has the best central banker in the world. So, India probably tick criteria 1. But as for the rest of the criteria… 😉

  • @anon

    I guess we could bounce here short term.

    That's the difficulty with today's market. By right, there should be deflation (including deflation of asset prices) and the world should be in Great Depression II now.

    But Bernanke (who is confirmed to be re-appointed) and the political establishment would rather destroy their currency than allow deflation on their watch. So, they will print more money.

    The market may sell-off, asset price fall, then they will print more money, bail outs, stimulus and so on. That means asset price will bounce up. Then rinse and repeat, rinse and repeat,…. until there's a currency crisis somewhere.

    That's why Marc Faber reckons the market is going to be range bound in 2010, thanks to government intervention.

  • Pete

    I had good timing on my exit, but it is probably more luck than foresight. I was just getting very nervous.

    That said, I feel nowdays things can easily go either way in the short-term. The markets have proven already that the fundamentals mean little to them, only good or bad news seems to make a difference.

    The issue there is obviously that the news can be (and is) manipulated when it is perceived as so influential on the markets. China seems to be better at this so far than the US is.

    Yeah, the 'speccies' (i assume small-caps?) are likely to get smashed up the most as I think they cannot absorb large quantities of downward share movements as easily as the big fellas.

    I didn't listen to BG's podcasts, but did look at the articles. Whilst I like the Gates Foundation's work, I don't necessarily believe in BG's approach to many things.
    Eg, fixing Africa's poverty is not a simple task. Definitely not as straight forward as he suggests. It would probably be easier to get accurate GDP figures from China.

  • Pete

    Haha, thanks CIJ 🙂

    At the moment Australia ticks most of the boxes. Although, decent Tax laws probably not. And not so sure about the future of the currency. I guess, once the currency of any country goes, most of the other criteria will go aswell…so, it is not so much what a country can offer now, but rather when the crunch times hit.

    Another one for Nostradamus eh? 🙂

  • Anon

    “I had good timing on my exit, but it is probably more luck than foresight. I was just getting very nervous.”

    I had that exact feeling aswell…didn't act upon it. I usually do, but hesitated…and hesitation = loss.

    “That said, I feel nowdays things can easily go either way in the short-term. The markets have proven already that the fundamentals mean little to them, only good or bad news seems to make a difference.”

    Yep. Lately the markets are just smashing good news and bad alike. Not a good sign for future market direction.
    On a historic basis altho the Pe is high the price to book value of the market is around historical averages, so I wouldn't say the market was overpriced. I would say the market was pricing in a recovery to perfection and now the market is discounting this due to obvious uncertainties that were all swept under the rug previously.

    “Yeah, the 'speccies' (i assume small-caps?) are likely to get smashed up the most as I think they cannot absorb large quantities of downward share movements as easily as the big fellas.”
    Yeah, thats exactly right. It was the illiquidity in those stocks during the last financial panic that presented huge opportunities for mispricing, but alot of the prices have just become unrealistic. I haven't bght any small caps for awhile. I could only really see value in currencies (for future investment ops) and larger caps. Funnily enough it was my large caps that did most of the damage and the small caps held up. Altho I would be silly to expect this to continue hence my selective selling.

    Regarding old Billy Goat, I find some good stuff from him at times…he has regular contact with Warren so one would assume he might let slip some info that Warren would be unlikely to tell the public. He recently mentioned the recovery will take a few years and not to expect much this year.
    Regardless of all this uncertainty I still think we will be higher this year. Since 1871 the SnP 500 has only gone down slightly a few times in the second year after a significant down; generally it was an up year. But the volatility getting there will spook many investors no doubt.

    Remember above is not advice, just commentary, go see a financial advisor 😉 Remember not to trust financial advisors that say any of the following words — trust me, I can make you rich, you cant lose.

  • Anon

    “The market may sell-off, asset price fall, then they will print more money, bail outs, stimulus and so on. That means asset price will bounce up. Then rinse and repeat, rinse and repeat,…. until there's a currency crisis somewhere.”

    So essentially this is like the Japan situation?
    I know there are differences but both markets reacted to stimulus and money printing, presumably US/world would tank when stimulus is stalled removed.
    It seems like alot of people are going on about this impending inflation because of money velocity/money supply/printing etc.
    However if we have several years of deleveraging which some hedgies have suggested inflation could be some years off. Is it possible to have deleveraging and inflation.
    I still dont see how you can cause inflation if the consumer/business is deleveraging. Atm they threw a tone of money into the system and inflation figures (altho distorted) are not even showing anything serious on the inflation front. Perhaps we will have several years of disinflation and as more and more money is printed and pumped into the system it will eventually lead to excessive inflation.

    Remember above is not advice, just commentary, go see a financial advisor 😉

  • Pete

    Yep, mostly with you on everything you said. Dunno about being higher this year, but I don't know much anyway.

    Not sure if there would be any financial advisors left to choose from with that disclaimer 😉

  • @Anon

    Yes, we expect sort of Japan scenario in the short term (medium term at the max) except with a bias towards inflation. This applies to the US because it has the world reserve currency.

    If a similar thing happen to small countries like Australia, there will be currency crisis.

  • Pete

    Looks like things are up again!

    Next leg?

    I give up on the stock market…happy one day, sad the next, urrgh! 🙂

  • Anon

    I dunno Pete, as I mentioned before, the volatility is going to take alot of people out; but I believe we will be higher by years end.

    Seems like there is slowly but surely ppl moving from small caps to larger quality types. My small cap portfolio didn't even rise today; did didly. But then again I dont own much in commodities so I'm guessing small commod caps bounced hard given their falls.

    Overall some Commodities look in trouble, BDI collapsing, stockpiles of base metals at March 09 levels, China buying much more commods then they need short term. Inflation not showing anything out of control. Will be interesting to see how this plays out.

    I reduced some hedges but I'm trying to remain nimble. I am not sure this rise will be sustained.
    10,500ish (djia), 4800ish (xao) looks like heavy resistance, but higher highs cant be ruled out nor can lower lows.
    On the currency front, I think the EURO is now oversold given how much bad press is out on this and technically looks due for a bounce, for how long is anyones guess.

    Knowing the markets, everything we say here will be the opposite of what happens tommorrow lol.

    Remember above is not advice, just commentary, go see a financial advisor 😉