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.