31st October 2011
But how much do currencies matter to investors? If it comes down to an either/or choice, the jury is perpetually out on whether getting the currency right or picking the right stocks produces the bigger gain. As with so many financial number questions, you can slice and dice the figures to suit your starting thesis.
The pro-currency people say investors ignore foreign exchange at their peril. They point to the tyranny of indexes in a home currency – Japan looks a disaster because the Nikkei index never seems to go anywhere positive. Five years ago, it was trading around 18,000 – now it's half that.
An unmitigated disaster for UK investors? No. The Nikkei 225 is for yen-based investors. Against sterling, the yen has doubled over the same period from 240 yen to around 120. The two factors have balanced out.
The pro-stock pickers say shares should react to the currencies that matter for the particular business and take changes on board, negating the currency effect.
Where both agree is shares are volatile, but currencies are relatively stable for long periods with swift and brutal re-alignments.
Sterling, for instance, had a long period of trading around €1.45, followed by a swift fall leaving it in the €1.08 and €1.16 range for two years -despite euro crises.
By contrast, the FTSE 100 index lost 20% between early July and early October and regained much of that loss over the past week or so.
A new period of currency re-alignment?
Now we could be set for another currency sea-change. According to The Financial Times, an overnight intervention by the Japanese authority to hold down the soaring value of the yen, could launch a new period of dollar strength with repercussions ranging from the forecourt price of petrol to the value of international equities.
The yen initially lost 5% against the US dollar but closed about 3% lower. The yen has gained 41 per cent against the dollar and 46.9 per cent against the euro since January 2008.
The yen intervention, early Monday, comes as Japanese exporters howl with pain at the high level of their currency. Bloomberg reports that japan's move to weaken the yen for the third time this year has to be "followed up with additional measures to help industries reeling from the strong currency."
Japanese firms say they would be happier at 90 yen to the dollar, making Japanese exports more competitive or increasing profitability or both.
Mindful Money blogger Shaun Richards is sceptical of the Japanese downwards push on the yen and fears a currency war to force devaluations. He says: "With all the fuss over the euro, investors have tended to overlook the yen/dollar rate. I don't think this latest attempt to bring down the yen will hold – they've had various tries at it. There's some investor psychology at play – if a currency has to be pushed down by its own central bank, it must have intrinsic strengths that will resurface."
Richards says the carry trade is responsible for much of the yen's strength – as it has been for a large part of the Swiss franc's rise. Here borrowers sell a currency with low interest rates to pay for debts in high interest currencies such as the Hungarian forint. But as they repay the debt, they need to buy the low interest currency, forcing it up and making repayments more expensive.
"The carry trade was free money before the credit crunch. Now it has to be paid for and it is not going away," says Richards.
So where does that leave the greenback?
Despite exporters' misery moans, the US dollar is likely to trend higher. Why?
· The safe haven effect. Despite rating agencies downgrading US debt, the dollar remains the most secure currency. Besides, its sheer size ensuring it dominates currency markets, it is not reliant on commodities (as is Australia whose own dollar has been strong) or exports (Japan, for instance). There has been a lot of discussion on where investors can park their money during turbulence – and the dollar seems the most likely candidate.
· Politics. The Republicans, and especially the right wing of the party, seem to be making the running with 12 months to go before the next US elections. Their concept of fiscal rectitude will chime well with financial markets.
· Recession. If fears of a new recession, or worse, are justified, then dollar-denominated assets could be the international investor's home of choice. The argument goes like this. Low, no or even worse on the growth front equals barely perceptible returns from bond markets (and negative results on shares). But if the dollar is rising in value, non-US investors can chalk up gains. And the quicker they pile in, the more they get of the predicted increase.
What will the effect be on commodity prices?
Most commodities are denominated in dollars. So if the dollar strengthens, the commodity price should move the other way. Some of the recent gold price upsurge was due to. But this is not an exact relationship and there are other factors – including supply and demand – in play. An extra factor is currency – if investors believe the dollar will gain 10% while the commodity loses 5%, they will pile in, pushing up the dollar.
Does it matter for equity investors?< /p>
Dollar strengthening increases the sterling value of US shares but these shares could be hit by the effect of lower demand on corporate earnings.
Is there a solution?
According to Richards, we could see attempts at competitive devaluations – currency wars – of the kind that destabilised world economies in the 1930s as each country tries to make its own exports cheaper.
"To prevent this, the authorities must stop policies of monetary expansion – stop printing money in other words. The world has to change course as the dollar has been destabilised by all the excess money. There are already three dissenters on the Federal Reserve who are against the printing of new money. That leaves up to nine still to be convinced."
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