Currency war and its impact on your investments

By: ispeculatornew
Date posted: 12.08.2010 (5:00 am) | Write a Comment  (2 Comments)

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You might have heard about what is going on. It’s not some crazy left wing or right wing theory, it is very real. Economies all around the world are struggling to pick up and fully recover from the very recent recession. Some economies such as the US have recovered better than others but even those still have very serious issues such as high unemployment, real estate prices uncertainty, etc. That has spurred many governments to look for ways to get their economy back on track…

The easiest way

Of course, the easiest way to get an economy going is to increase exports. Why? Because that means that foreigners are paying for products to be produced. Let’s take the US. The government has been trying to get its trade deficit improved which can be done by increasing exports and/or decreasing imports. There are many ways to get this done:

Decreasing exports: Add tarriffs (such as what is often being discussed against the Chinese, it makes foreign products more expensive), weaken the currency (which also makes foreign products more expensive).

Increasing exports: Signing free trade agreements, subsidizing programs that can increase exports and also weaken the dollar (which makes the goods & services produced in the US cheaper for freigners).

A cheaper dollar = solution?

How does that work exactly. Let’s imagine a scenario where 1 $USD is worth $2 CAD. In that scenario, the US dollar is very strong and it makes it difficult for the US to improve its trade deficit. I will simplify things a bit but here are 2 examples:

-US Producers will need to sell twice as much in $CAD in order to make the same revenues – All sales in $CAD are divided by two when converted back into $USD.

-It becomes very cheap for Americans to buy Canadian goods. If a product is priced at the same price but in $CAD, US consumers will tend to buy the Canadian good.

Now, through different strategies, the US government could decrease the value of the $USD. For the sake of simplicity, let’s imagine a 50% decrease where 1 $USD = 1 $CAD. In this scenario:

-The same amount of products exported to Canada will have twice the value if sold at the same price (result = Exports increase)
-US residents will no longer have the same incentives to shop for Canadian products (result = Imports decrease)

End result = Trade deficit improves which is often seen as the best and easiest way to quickly “fix an exonomy”.

How to devalue a currency?

There are many ways to devalue a currency and one of the easiest ones is to print money. If the US Treasury decides to print money, that has a direct impact on the value of the exisiting money. It decreases it. Other methods exist to get the samme result (such as the government trading foreign exchange to influence the value of its currency) but printing money is by far the most popular method at the moment.

The problem here

There is one big problem in this big idea. Since almost all major world economies suffered from major slowdowns in the recent economic crisis, they are all using this method to get their economies back on par. Of course, that makes it much less effective. If the US and Canadian governments both print money in equal proportion, both of their dollars will see no currency depreciation (against each other). If all countries do the same, it nullifies the effects all around the world. And that is exactly what’s happening.

In fact, the G20 members have all made statetements regarding the major problem that this currency war is causing. It’s not quite clear how it can get resolved. Why? Because every member has an individual interest in having its currency depreciated. Since all countries think about the recovery of their own economies above the recovery of the world economy, it has created the potential for much more serious problems.

Side effects….

There is another issue as well. Not only are these measures not effective when so many governments are trying the same tactics but as important, these strategies can have very serious side effects. Since the most used strategy to devalue currency has been printing money (nowhere more than in the US might I add), I would like to ask you what the consequences are of printing money over the medium to long term…


With governments printing money, one of the primary sources of worry for financial analysts is that inflation could pick up. Historically, printing money has had one common effect in almost all cases; it has produced inflation. That means the value of most assets and of money drops and can be quite dramatic for investors and the population in general.

What it means for your portfolio

I think there are two main investments that could benefit greatly if this depressing scenario becomes reality.

Gold: There are two important reasons why buying gold and Gold ETF’s could turn out to be a winning strategy:

1-Inflation hedge: Gold has been a very good historical hedge to inflation and buying gold, silver, platinum or other metals is a good way to protect yourself.
2-Currency: As all countries try to devalue their currency, some important questions are being asked about the current monetary system and how it can manage such situations. There are no easy solutions but it becoming clear that having the $USD as the reserve currency is far from a perfect solution, and many governments are moving away and putting some reserves either into gold or other currencies. It is unclear how things will evolve but there is a growing rumor that gold could have a more central role if things were to change. I think these two scenarios are a big part of the reason why gold has been rising so fast as it heads towards $3000.

-Inflation ETF’s: These ETF’s are either straight inflation plays that mix different assets for you but you can also get TIPS ETF’s that invest in inflation protected treasuries. These are the best way to get direct protection and although you do still depend on official government figures, I think we are still far from the point where serious doubts exist about those figures. TIPS are thus a good investment to have.

While I think that gold and TIPS are both the most obvious ways to invest for such a scenario, I think it’s important to keep in mind that this is just a scenario. It is a possibility but it’s difficult to say how far things will go. So putting your entire savings on one scenario would be foolish. But not preparing at all could turn out to be foolish as well.

Side Plays: Short the US dollar?

Another interesting way to invest in this scenario is to think about shorting the US dollar through ETF’s. The US dollar has been very volatile and it could increase as well so there is risk involved. But in a scenario where the monetary system is reformed, there is no doubt that it would have significant consequences for the US dollar….

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  1. Comment by VeRo — December 8, 2010 @ 8:09 am

    Thank you, I understand it all a lot more now! You made the currency “war” clear to me. I was wondering, is Canada still printing money? I don’t think so, but could you reassure me?

  2. Comment by IS — December 10, 2010 @ 5:34 am

    @VeRo – Not nearly as much as others for sure:)

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