How to survive and thrive during the currency wars

Just over two years ago, Brazil complained that developed nations were engaging in an international ‘currency war’.

Turns out that was just a minor skirmish. Now the big guns are coming out.

Japan is fed up with being the whipping boy of the foreign exchange markets. A strong yen will no longer be tolerated. This morning the Bank of Japan adopted a 2% inflation target and effectively promised to do whatever it takes to get there.

But Japan’s not the only one. The Norwegians are now gently hinting that they don’t appreciate the strong krone, which hit a record level earlier this month. And the South Koreans are really rather irritated by Japan’s efforts to weaken the yen – their exporters have been the main beneficiaries of Japan’s pain.

In short, it looks like the currency wars will only get hotter this year. So how can you prevent your portfolio from being shredded in the crossfire?

No one wants a strong currency

The idea behind the currency wars is very simple.

No country wants a strong currency. Loosely speaking, a strong currency is bad news for exports, because it makes them more expensive.

Here’s the problem.

On the one hand, you have countries like Britain and the US. Britain may be the best example. During the boom years, it depended upon rampant consumption, government spending, and financial sector jiggery-pokery for economic growth.

Then the credit bubble popped. And those sectors are now in a slump from which they may never fully recover. The great hope for Britain is that it can make its manufacturing sector a much more significant driver of growth. That means trying to weaken the currency to boost exports.

Now there are lots of reasons why you could argue that this doesn’t make much sense. The pound has already lost a lot of ground since 2007, and it hasn’t exactly lead to a miraculous manufacturing revival. But that’s the theory anyway.

So the heavily indebted ‘consumer’ countries want a weak currency because they want to ‘rebalance’ their economies towards exports. Another side-effect of a weak currency is that it boosts inflation, which helps the indebted to pay off their bills with devalued notes.

This is all very well. However, the export-driven countries don’t want to stand around with their hands in their pockets while the consumer countries are printing money and chasing savers towards ‘safe havens’ like the Swiss franc or the Scandinavian countries – or even the yen.

If their currencies get too strong, they will start to lose business. The Japanese have lost a lot of ground to South Korea due to the strong yen, for example. Indeed, pressure from beleaguered Japanese manufacturers is one of the main reasons why Japan’s politicians are finally trying to do something about deflation.

The Swiss, meanwhile, drew a line in the sand a while ago – explicitly saying that they wouldn’t let the euro get any weaker against the Swissie. They ended up having to print a lot of money to stick to that promise, but they managed it. And as noted above, the Norwegians are starting to complain now too.

In short – everyone wants a weaker currency. But they can’t all have one, all at the same time. So you can expect a lot of ‘jawboning’ (talking a currency down) and other unexpected interventions in the market this year, as each nation struggles for advantage.

So what can you do about it?

Of all the financial markets, I have to say I find currency markets the most fascinating. It’s where you get to see reactions to economic and political announcements most rapidly. And it can sometimes give you a heads-up when a long-term trend is changing.

If you have strong feelings about a specific currency, the easiest way to follow your hunches is by spread betting the markets. Our trading expert John C Burford has a free email you should sign up to if this appeals – MoneyWeek Trader.

However, while spread betting the markets can be fun, for most of us it’s not a realistic way to build a retirement pot. (Indeed, you can lose a great deal of money very quickly, so treat it with caution.)

One of the main lessons we all have to draw from recent years is that markets are now very much at the mercy of politicians and central banks (which are basically one and the same thing – except you don’t get to vote on who runs the central bank). We like to call this era ‘The Great Distortion’.

So while you can have strong views on which currencies will thrive and which won’t (we’ll be discussing our own views on this topic in a MoneyWeek magazine cover story in the next few weeks), it’s very easy for your best-laid plans to be scuppered by a stray word or deed from an official.

As usual, the solution is to have a balanced portfolio. You don’t want to pin all your hopes on one specific asset or country. Instead, you want a mix of exposure.

If you’ve been a MoneyWeek or Money Morning reader for a while, you probably already have a decent bit of money in European stocks, and Japanese stocks. You also probably hold many big blue-chip London-listed companies with overseas and US dollar earnings. We’d stick with those.

And if nations around the world keep trying to push down the value of their currencies, it should be good for the price of gold. We’d suggest having around 10% of your portfolio in gold as insurance – we wouldn’t have more than that. Even if the dollar price doesn’t move much, as a sterling investor, you’ll probably be glad of your gold holding – my colleague Merryn Somerset Webb points out why in her latest column.

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• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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  • dlp6666

    A useful perspective, thanks, John.

    This all makes me wonder whether it is better to hold funds holding global shares in the ‘hedged’ versions of those funds (if available).

    So if a currency does indeed get weaker (as you point out all countries are keen to achieve) then at least your investment in that country’s shares within the fund, hedged back into GBP, should retain its value.

    I’m thinking particularly of Japan – though if the currency-weakening operation doesn’t work, then presumably we’d be better off in funds that aren’t hedged and are exposed directly to the (strengthening) foreign currency.

    Any thoughts on how best to approach currency-hedged funds, please?

  • Pom in oz

    which relatively speaking is pretty tame. Plus the housing falls often talked about in Aus are still not happening. All of which is a little frustrating as a Brit abroad waiting to transfer his pounds to Auz$. I can’t see the pound strengthening anytime soon however an update on which currencies you think are worth betting against would be appreciated.

  • aff

    If everyone is trying to weaken the currency to boost exports who will be the consumer buying them?

    I don’t think the money printing is ‘to boost exports’ although that can be a plausible sounding excuse for it. The real reason is to screw savers so that the biggest debter (govt) can pay for it.

    Incidently I know i’m just some random bloke on the internet but I’d suggest you put a lot more than 10% into gold.. 50% into gold and the rest into silver.

  • The Wolfster

    Gold Gold Gold, that’s all your lot ever say, I am guessing you are heavily vested in Gold, am I right ???

  • aff

    I don’t know why it is gold gold gold. Silver is the one to watch.

    Heavily suppressed in the futures market, combined with reputed physical shortage (caused by suppression) = potentially sudden explosive move up

    Has monetary qualities rivaling gold or even surpassing it from historical viewpoint which provides protection from inflation. Unlike gold from the other side also industrial uses, solar panels, electronic goods

    from technical standpoint, there is a huge decades long cup and handle with the handle almost complete.

  • jrj90620

    These govts/central banks are just taking advantage of money illusion.They could ask their citizens to take less pay,so the country’s companies would be more competitive,to export more.They know that wouldn’t fly.So,they do the same thing by devaluing the currency.The employees get the same nominal pay and companies get the same income,but in devalued fiat currency.I’m sure that most people would prefer a 3% raise,with prices inflating at 10% than no pay increase and 0% inflation.So,as usual,govts can depend on the ignorance of their citizens.The few who understand the game can hedge,but the ignorant majority will just suffer.

  • Reality Check

    Why take chances with any FIAT currencies.

    Hold Gold or Silver as that is real money. Except no substitute.

  • jackanory

    Forgive me if im wrong but I believe that gold has hit its peek and if it goes any higher the currency has collasped and the goverment is going to take your gold anyway!

    Sell it now, afterall everyone thinks the currency is going to fall, therefor it wont.

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