Ok, there is a question for you all. What is the best way to handle the decision of how much to hold in which currency? Assume for the moment that you have no particular view on the price or value of any currency. This choice is actually more tricky that it appears. Take a US citizen, for example. I bet almost all of them have all their money in dollars. Well, this creates a problem. What happens if the dollar falls 75%? If you just live and work in the USA, this is not *too* bad, since your local costs have fallen too. However, what if you travel frequently, and spend up to half your time and living expenses abroad, say Canada or Mexico or the Caribbean, and some trips to Europe and Asia? Suddenly, for that half of your life, you are 75% poorer. Beers now cost $12, a meal costs $200 at a family restaurant and $1000 at a good restaurant. A car abroad costs $50k for a beater and 500k for a Porsche. Basically you just got fucked. The reason is you had a huge FX risk without realising it. Effectively, in this situation a 100% dollar position is not "flat". You have half your expenses in non-dollars, so what happened was you were short non-dollars without realising it. Imagine letting a short go 300% in your face with no stop. Well that's what just happened in this situation. So the way to control risk appears to be to work out your expenses and then distribute your assets accordingly. So if 10% of your expected expenses are in Canadian dollars, for example, a 'flat' position is 90% dollars 10% CAD. However, it's not quite that simple. Firstly, you don't know what your expenses are going to be in a year, and especially not in future years. Maybe in year 3 you want to emigrate to Japan or France or Australian, and live there for 5 years. What if that currency is up 75% by the time you move? You just got fucked again. Secondly, if you try to hedge by keeping money in your expense currencies on a proportional basis, you incur tax liabilities if the foreign currency appreciates. Let's say the dollar halves so your CAD double. You pay capital gains on that, even though you have made NO economic gain at all because your CAD expenses have doubled too. So if you do this long enough, you will get taxed into bankruptcy because you are being taxed on making no money on the way up and then can't claim deductions or refunds on the way back down. Next, let's pretend you can ignore the tax and relocation issues. Make it real simple: 50% in US, 50% in Europe. So you have 50% USD and 50% EUR. Now you see the European debt problems, so you become concerned about your Euros long-term value. Ok if the Euro falls 30% half your expenses do too. But if you later want to live in Asia, you just lost 15% of your purchasing power. So maybe you think of selling your Euros - but putting them into what? Dollars are your only other base currency with regular expenses. So now you go 100% long dollars - well, with Bernanke at the pump who knows where the dollar will be in 2-3 years? Maybe the Euro AND the dollar both collapse. Fine if you intend to live the rest of your life there, but if you don't, again you risk taking a huge loss relative to other global currencies. And you can't escape the risk by buying Asian currencies - if you are wrong and the dollar and Euro rally back hard (maybe Bernanke goes hard money on us lol) then you just took a whopping loss and you don't have the cushion of falling expenses to offset it either. I'll give a couple of examples in the next post:
In the early 2000s the dollar was very overvalued. 0.83 to the Euro. 0.48 to the Aussie dollar etc. So let's say as a US citizen posted abroad you don't want to lose 40% of your net worth as the dollar collapses, what do you do? Do you put all your cash into Euros? Spread it between Euros, GBP, Yen, Canadian? Well, even if you did that, and you were 100% right, you still had issues. The dollar had several rallies of 10-15% during its decline. So you had periods were your net worth collapsed 10-15% in a few months, despite wanting to minimize risk. So if you don't want that volatility, you have to buy less foreign currency. Let's say you can only stomach 5% volatility, so you put 1/3 of your assets abroad. Great - but then by 2007 you had still lost 40% of your purchasing power on the 2/3 you kept in dollars. Maybe you could have gone into gold instead, which would have been a prescient move. But would you go 100% long your entire net worth into an asset that several times fell 25% in a few months? That seems like even more risk. Basically there was no way to both protect your purchasing power and to keep risk at acceptable levels. A similar story happened with the pound. In 2008 it was at 2 to the dollar, expensive on purchasing power basis, and the UK economy being exposed to real estate and finance was about to fall off a cliff. One of the most obvious short-selling opportunities of all time. How was a UK resident/citizen supposed to act? If he sells all his pounds for dollars or Yen, even if he is right, he is looking at gigantic swings on the way down. The pound went from 1.52 to 1.65+ in a few days during late 2008 for example, it was even more volatile vs the Yen. Worse still, even if he had the balls to do that and hold on for a 30-40% move down in the pound, let's say he then takes his profits, where does he stand? Well, he has ZERO PROFIT in dollars or Yen. He converted his pounds into Yen/dollars - and 12 months later after the pound collapsed, they are worth exactly the same number of Yen/dollars. Except being able to buy cheaper UK goods, he has gained nothing at all in ability to buy things internationally. To profit, it would be required to not just convert all his pounds, but to then actually go short on top of that. Now think about this for a second. You put 100% of your assets outside your home currency, but to make so much as 0.1% profit in FX terms, you have to then place a further position. But if you do that, and you are wrong, you are screwed because you are 100% de facto short your home currency, and then have another 30-100% outright short position on top. This home currency problem means that in FX you have a Hobson's choice: i) stay put in home currency. Foreign goods can skyrocket and you will become poor internationally as your currency turns into toilet paper. ii) convert fully to foreign currency. Even if 100% right, you don't make a dime in foreign currency at the end of it. But if 100% wrong, you take the full loss in local terms. Either way, you experience gigantic risk and volatility. iii) convert parially to foreign currency. This means you will lose substantial sums even if you are 100% right about the devaluation. iv) convert fully to foreign currency. Then go (say) 50% net short local currency (e.g. via futures shorts). You make 50% times the devaluation if you are right, and lose 150% times the local currency rally if you are wrong. vi) hold a diversified portfolio of major currencies. Offers some protection, but since they are generally highly correlated (most currency choices boil down to dollar strong vs dollar weak), it's not that useful. Then there's a further problem. Which currency do you pick? Look at today, where the Euro, Pound, Aussie dollar, Canadian dollar, US dollar, Yen, and Swiss Franc all could have a convincing case to fall substantially in the coming years. If you aren't an outright bull on any currency, it is difficult to decide where to place your cash. Gold will protect you against fiat devaluation but is very volatile and you need to go 100% long to zero out your fiat exposure. Welcome to 20-30% swings in net worth based on the whims of commodity speculators. And this is just taking a simple scenario of someone in a home country, with some trips abroad. What about someone who roves around the world, such as an international business consultant? What about people from countries with unstable home currencies, like Russian oligarchs etc? To me it looks as though it is basically impossible not to take substantial amounts of risk no matter what you do. George Soros called this an "existential choice" about what currency to hold. In every other part of trading you can choose your risk level - if you want to risk 1% per trade, you can do so easily. But when it comes to currency, it looks like you have no choice but to take truly humongous risks in the order of 50% or more. Even a diversified G7 currency portfolio can get raped in a high inflation scenario, or y ou could just get whipsawed to death in an era of competitive devaluations. Does anyone have any potential solutions for this dilemma?a
No, in international terms they will collapse. When the pound fell from 2.10 to 1.37 vs the dollar, London and the UK became a lot cheaper for Americans, Russians, Arabs etc.
I like the subject and it is someting which is on my mind frequently. Against what do you measure your wealth and increase in wealth. Say you are an international traveller without any permanent place of residence who has most of his money in gold. Gold is up 2% in USD but down 1% in Euro's. Did he made a profit?
again nonsense. re:"this is not *too* bad, since your local costs have fallen too. " if u are living in the US the cost of everything will rise. I suggest you study inflation rates in countries where the currency has collapsed.
My solution is this... Given I'm gonna be f*cked whatever I do, I will be holding as diversified a portfolio as possible. I would also make some effort to forecast (to some limited extent, all the usual caveats apply) the distribution of my future costs across ccies.
it depends at a given point what u turn your gold into and what the rate of inflation is. maybe u lost to inflation.