What can you do to protect yourself from increasing currency volatility?

September 19th, 2010

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Six months ago, we wrote about America’s consideration to label China as a “currency manipulator” in Watch April 15 2010: simmering tensions between US and China. Just before the deadline, China appeared to make a little concession about their RMB, thus avoiding the “currency manipulation” label.

Today, currency tension between the US and China is rising again. The little concession that the Chinese government made was simply not enough. American lawmakers are getting impatient and are itching to enact laws to slap China with trade sanctions. Should that happen, it will be the beginning of a damaging trade war between the world’s largest economies. Their charge is that China’s artificially low currency is responsible for (or at least contributed to) America’s economic woes. But as we wrote in Watch April 15 2010: simmering tensions between US and China,

But the mob wants to find a scapegoat to blame for their woes. It so happens that the most convenient scapegoat is China (specifically, China?s policy of artificially holding its currency down) because at this point of the cycle, China is looking very good. It is perceived that this policy worsen America?s unemployment rate. By implication, it is perceived that with China?s official unemployment rate much lower, China is ?prospering? at America?s expense.

Currency tensions between China and the US are nothing new. As we wrote in that article, it’s been around for the past 3 to 4 years. Many times, the rhetoric about America labelling China a “currency manipulator” came and went away without eventuating into reality. However, that does not mean that it will never happen. As America’s economic woes worsen, the pressure to find a scapegoat will increase. As a result, the probability of a trade war will increase.

The Chinese, on the other hand, are not standing idle, waiting for a trade war to happen. For starters, they are establishing trade and investment links with Asia, Middle-East and Africa. Secondly, it is no secret that they have been diversifying their colossal hoard of reserves away from the US dollar. Given the well-known intention of the Federal Reserve to print more money, diversification has become increasingly urgent. But that in itself is not easy because given the colossal size of the money involved, any whispers and hints about any particular Chinese diversification strategy will move the markets quickly in a big way. For example, the recent rumours that China was buying up Japanese government bonds probably helped to contribute to the surging yen. As a result, the Japanese government became very unhappy because a very strong yen will negatively impact on their export-oriented economy. In response, the Japanese government may take concrete actions (beyond just talking about it and taking token measures) to weaken the yen, in which the end result is more Japanese purchase of US government debt.

In such an environment of competitive currency devaluation and price volatility, what should investors and savers do?

To us, it is clear that having all your savings and investments confined to a single country or currency is an increasingly risky proposition. Currency exchange rates will become more volatile, with implications on asset values, price inflation and economic growth (see Real economy suffers while financial markets stuff around with prices). For example, in Japan, real businesses are suffering as a result of the rising yen. The Germans, on the other hand, are secretly gloating whenever the euro weakens. In Australia, should the banking system fall into a crisis as a result of the bursting of the property bubble, the consequence of a resulting collapsing Australian dollar will be price inflation (see Can price inflation occur in the midst of debt deflation?).

If currency volatility goes to the extreme, investors will even have to question the idea of national currency as a store of value. So, what can investors and savers practically do to mitigate against this?

Quite some time ago, we talked to the guys at GoldMoney.com and learnt of how a lot of their clients (presumably the “rich”) use them. In case you do not know, GoldMoney.com (a regulated company operating in the financial services industry) enables

… you to hold gold, silver & platinum that is fully insured and stored securely in specialised bullion vaults in London, Zurich and Hong Kong. All metal is owned directly by you with no counterparty risk.

You can “easily buy gold, silver & platinum and take delivery of physical bars of gold.”

What their clients did was to use their GoldMoney.com account as a conduit to link their bank accounts all over the world. This strategy makes sense as it gives investors and savers the flexibility to shift their savings all over the world, using gold, silver and platinum as an anchor for the store of value. In an environment of currency volatility, this flexibility is a valuable aid in helping to protect your hard-earned savings from hare-brained government interventions.

However, for those who are ultra-pessimistic and distrust any assets that have any hints of paper, the only way to go is to take possession of physical gold and silver (see How to buy and invest in physical gold and silver bullion).

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  • Pete

    If all the other currencies are racing to the bottom… what about the AUD? If we don’t race to the bottom, what then? Our export sector will suffer, but our imports will be cheaper.

    Does this play into the hands of Rudd’s idea of making us a ‘financial mecca’?

    I hope not, it sounds horrible.

    Go gold!

  • If AUD gets stronger, our tourism and educational industry will suffer. Our manufacturing will also decline.

  • Pete

    It’s seems that it is pretty much all bad if the AUD appreciates.

    And if it depreciates, it will help our exports heaps. Except that we will have a huge crutch in our overseas borrowing will cost a lot more, and international investors will tend to take their money away. Plus, the cost of living will rise a lot.

    So, high AUD = happy mortgagees.
    Low AUD = happy exporters.

    Is there a middle ground? I think it is increasingly illusive. Two competing forces…but the least productive one is unfortunately the one that is most socially popular (high AUD).

  • Pete

    Thinking aloud here:

    How would the CPI fare with a higher AUD? Surely that means most of our costs will actually go down – so CPI inflation would fall. What will the RBA do then, assuming they look at the CPI? They will have less excuses to increase rates.

    Also, international investors may flock to the AUD, as it would be an increasing store of wealth, especially for those people living in countries like the US and Japan who have Govt’s frantically devaluing their own currency. In relative terms, it would be a profit, but combine this with high deposit rates and it’s a bit of a no-brainer. High risk, but still, profitable.

    Based on these, could an increase in the AUD actually give our property bubble another leg up? Lower deposit rates (thanks to the international investors deposits mentioned above) and potentially lower rates set by the RBA (if they have no inflation to fight), plus lower cost of living and plentiful investor dollars flowing into Australia…
    It would be bad news for the country in general, but good for some? If property bulls were starting to question themselves then such a rebound would confirm their ‘genius’ (*cough*) and they’d be even more susceptible to losses when the tower of cards finally does start to fall. But I am jumping to conclusions here.

    It makes me wonder, is Australia in for a Japan-like slump? We might get another boom followed by a very long bust when the magic is gone?

    On the plus side, this is good for Australians wanting to buy gold. We’re in the best position ever to accrue a small fortune in it.