How to win the Currency War? 23 February, 2013.

How to win the Currency War?   23 February, 2013.

The music has stopped and this time, EU has stolen the chair from the UK.  The media, economists and hedge fund managers are now saying Sterling should be weaker due to a sleepy economy, broken banking system and a no way out government budget. Sterling has been falling from USD 1.6293 before Christmas to USD 1.5131 as of 22 February.  That’s a 7.1% drop which is a fair amount even compared to USD/JPY 11.9% drop in the same period.  What does this mean?

Let’s look at the weakening of Yen as an example.  The Japanese Prime Minister Shinzo’s Abenomic campaign is asking for a weaker Yen and lucky him, he got exactly what he asked for.  Abe has learnt a few tricks from Helicopter Ben in US and Draghi’s “Whatever it takes” tactics in Europe.  A weaker Yen has injected steroid to the Japanese stock market and Nekkei 225 went up from 10,000 level to 11,400 level.  Hang on, Nekkei 225 is in Japanese Yen which has weakened against USD by more than 11% and GBP by more than 4% in the same period.  So for those who invested in Japan Fund, the Japanese is laughing, the British is smiling and the American is unmoved.

In a Currency War, governments or Central Bankers try to weaken their own currency to improve their export competitiveness and “earn” foreign money.  A trick that the West has accused the Chinese for a decade to turn everything in their household “Made in China”.  Or if you look closer to home, the weaker Euro since Financial Crisis has helped German car makers to dominate the world.  (But why not the French car makers?)

A weaker currency to a country is similar to an individual worker accepting a salary cut.  It will make the individual more attractive to hire assuming he has competitive skills.  For a product or a skill that is non competitive, a discount may not be enough.  So Toyota car going on discount may make consumers choosing them over Volkswagen.  But Fujifilm offering a discount on its old stock is unlikely to convince digital camera users to buy film.

Will a weaker Sterling improve UK’s economy?

Should be good for Harrods, Selfridges and other tourists driven business, a weaker Sterling could mean more customers.  Not great for foreign workers in UK as their Sterling is now worth less at home.  ASDA will be tempted to increase wine prices as these wines are imported from Europe, US or Australia.  A side effect of a weaker Sterling is inflation.  The Government has already safe guarded property market to make it punishingly expensive for foreigners to buy luxury properties.  Unfortunately, the bread and butter for everyone is likely to get more expensive.  If a weaker Sterling does not create job, it is likely to hurt the unemployed and the retired.

For those who do not need to worry too much about the bread and butter, but have Sterling saving or asset such as property or gilts, they have to either hope their Sterling investment return can beat inflation or they could consider getting out of the Sterling.  Switching to US Equity Fund from Sterling investment is pivoting move, hoping for the US stock market to go up or at least outperforms Sterling against US Dollar.  If one’s Sterling investment is not possible to sell such as investment in SIPP or ISA, trading Foreign Exchange to long US Dollar and short Sterling to cover the notional value of the Sterling investment is an efficient hedge.  Please consult your financial advisor or bank on such Fx transaction.  If you have not traded leveraged Fx before, maybe you do not want to start.

Since the financial crisis, the American, European and Japanese central bankers are all printing money and distorted the bond and foreign exchange market.  Sending bond prices up and swinging Fx.  More importantly, the hedge funds all focus on liquid assets and government bonds and currencies perfectly fit the bill.  Hedge Funds’ herd action may have exaggerated market trend in both speed and magnitude as we have seen in the sharp fall of Yen and Sterling against US Dollar in the last 3 months.  Currency War between the big boys (US, Europe and Japan) is a round the world roller coaster ride that eventually goes back to where you start.  One cannot erase nor conquer the other.  But the ride could be years or decades as we have seen since in EUR from its date of birth to today.  For most people, it is not about making money from Fx swings but to survive them.  Business that import goods in USD, EUR and JPY, and sell in UK to earn Sterling are used to deal with the currency roller coaster.

Many people ask if they should buy Gold as its price has fallen to below USD 1,600 per oz.  My personal view is that Gold has become more of a tool for investment portfolio diversification but not a very effective hedge against inflation.  Many investors are looking for yield (coupon from bonds or dividend from stocks) and Gold does not offer that.  Another asset class that we need to get more cautious is the High Yield Bonds issued by corporates and government from Emerging Markets.  These bonds have rallied a lot in the past 2 years and got to the point that the coupons they pay may not justify the risk for the bond holders.  It is hard to be a happy investor but with bank deposit yielding nothing, investing is becoming a compulsory hobby.