How to survive and thrive during the currency wars

With the Bank of Japan the latest belligerent to enter the fray, the currency wars are certain to hot up this year. Here, John Stepek explains how to protect your wealth.

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.

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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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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.