Jan 162015

Yesterday evening I was fortunate to be amongst a select few who had the privilege to be invited to hear the investment advice of the chief strategist of a major Swiss bank. (I should mention at the outset that the vast majority of the audience’s reference currency is the Swiss franc.)

The speaker was clearly an erudite man and his delivery was flawless. The underlying theme of his speech was divergence in today’s economy: in interest rates, in GDP, in unemployment, in central banks’ strategies, and so forth. Render unto Caesar, his presentation was concise, well-researched and extremely persuasive.

The conclusion of his argument was the bank’s investment strategy. In a nutshell, Swiss and European equities present few opportunites. On the other hand, the USA appears to have left recession and is showing strong growth perspectives, which he estimated at around 6%. The bank’s strategy is thus to move their clients’ assets to Swiss and European gilt of the highest quality for portfolio protection and to US blue-chips for revenue.

When questioned on the Swiss National Bank’s strategy of locking the Swiss franc to a floor of 1.20 CHF/EUR, he was of the opinion that the floor to the Euro would be replaced by a floor against a basket of currencies, probably EUR/USD/JPY, sometime in 2015.

Were I to have followed his advice, this morning, first thing, I would have moved my investments into US blue-chips, the stocks that participate in the Dow-Jones Index: American Express, Boeing, Caterpillar, etc. in the hope of a return of some 6% instead of the measly percent or two that I get on Swiss franc holdings.

With the most tragic timing for our strategist, some 14 hours later the Swiss National Bank announced that it had abandoned the 1.20 floor. The effect was instantaneous: the EUR and the USD crashed against the CHF, settling at day-end to ~0.86CHF/USD and CHF/EUR at a similar rate.

Had I bought those American shares some hours previously, I would have taken a 15% hit on my portfolio in so-many hours; even if the strategist’s predictions come true, I’ll have to wait two and a half years before breaking even.

There are several lessons to be learned from this story:

  1. Despite everything that your banker, hand-on-heart, assures you, he has no interest whatsoever in your financial well-being. His sole aim in life is to persuade you to trade your holdings as often as possible so that he can gather a maximum commission. If, despite the commissions, you make money, he’ll congratulate himself on having helped you. If you lose money, he’ll appear heart-broken at your misfortune, which was entirely due to the unfavourable market.
  2. If your reference currency is the CHF and you invest in higher-yield USD-labelled assets, you’re exposed to the CHF/USD exchange risk. Momentarily you might get away with it; as this example shows, you are likely to take a caning.
  3. Inversely, if your reference currency is the EUR and you buy CHF assets, your yield will be much more frugal… but your capital will be better preserved.

The take-away from all this is that in today’s liquid markets there is no free lunch. If your ambition is to receive the rate of inflation plus a whisker on your investments, there’s a strong likelihood that you’ll get it. If your ambition is get 6%, be prepared to lose 15% momentarily when things go tits-up.

P.S. For those whose mother-tongue is not English, the title is a pun

Dec 212010

A year ago I wrote an article predicting that the US dollar would be worthless, against the Swiss Franc and the Japanese Yen, by around 2020. A year has passed and the US dollar has been falling in line with my prediction, so I felt it might be interesting to re-visit the subject with a slightly different tack. Also, today seems like an auspicious date for doomsday predictions.

Rather than dealing with absolute exchange rates, I set out to try and show the relative strengths of currencies amongst themselves. To illustrate, let’s suppose that a glass of wine costs 5 USD.

  • On day one, we buy a 100mL glass with a dollar’s worth each of USD, GBP, EUR, JPY and CHF.
  • A month later, we need a refill. The wine still has the same value, but the exchange rates have changed.
  • Suppose GBP has risen by X% (and nothing else has changed). As we’re buying the wine with equal fifths of each currency, the USD’s value must decrease by X%, thus we will to pay more USD and less GBP.
  • These increases and decreases change the relative strengths of the currencies, and it is this that we shall study.

This is nothing more than my own version of the Dollar Index. The maths is simple, as you may surmise from this Excel spreadsheet:  forex2010

A first look over the past decade seems to illustrate some trends (click to enlarge):

The first 2 years show a pronounced strengthening of the USD, in the aftermath of the dot-com boom, but as of 2002 the USD has been declining steadily. The Federal Reserve Bank of Cleveland wrote an eloquent paper suggesting that the decline was due to the US current account deficit. This correlation held for a few years, but the USD continued to fall even when the account deficit started diminishing in 2006. I find it reassuring that the experts’ tea-leaves are no better at forex predictions than mine.

Moving on, if we set the starting point in 2002, the picture becomes much clearer:

Notice that the stock market crash of 2008 occurred on the 16th of September 2008, yet the currencies tumbled 6 weeks earlier. The documented mass buying of USD and JPY started then, not in September. I wonder why?

From 2002 to 2008, the EUR was clearly the strongest currency, even through the crash, and things remained relatively rosy until Greece admitted to cheating in its financial reporting and more than doubled its deficit in late 2009.  The Greeks were followed by the Irish, the Portugese, et al in a landslide where most of Europe had to own up to the vast borrowing over the past decade.

For the USD, its been downhill pretty well all the way. 2005 showed a slight rally, at least in part due to the Chinese severing the dollar peg mid-year. The second rally during the 2008 crisis was due solely to panic selling and Obama’s election in January 2009 created but a short-lived blip. Finally, the first half of 2010 saw the USD gaining some lost ground, but it was quickly reversed once the Fed starting printing money in earnest.

Returning to the glass of wine analogy, if in 2000 you held Swiss Francs, today you’d get a 136mL top-up; if you held US dollars, you’d only have 82mL in your glass. If you see the glass half-full, that’s a 60% loss; if you see it half-empty, it’s a 66% loss, either way it’s a huge difference.

My predictions

The Americans have chosen to get rid of their debt by devaluation. They don’t care, it’s not their loss. I’m very bearish and if the Chinese start selling their T-Bills in the not-so-distant future, the USD will become worthless overnight.

The Brits will take their medicine better than most, but the GBP will continue to lose value steadily for many years to come.

Europe will never really get its act together, simply because a single currency doesn’t make a single mentality. Issuing more and more bonds to buy back yesterday’s borrowing is just a stop-gap solution to delay the inevitable devaluation of the Euro.

The Japanese, industrious and disciplined, will grind on and climb steadily back to a comfortable position, exactly following the slope of the last decade.

For lack of a floating rate, it’s impossible to foresee how the Yuan will progress, but even cave-dwellers can see that it can only be upwards.

Finally, Switzerland, as usual, will remain a haven for both clean and slightly-soiled money. Their relations with their European neighbours will degrade (for a good part due to jealousy), and like the Yen, I predict that the CHF will continue on its current slope.

Graphically, here’s how I see the relative strengths:

which in forex terms, looks like this:

In summary:

  • The GBP will fall more or less in step with the EUR
  • Near the end of 2012, we’ll see 100 JPY = 1 EUR
  • At the end of 2015, the big bang when 1 CHF = 2 USD = 2 EUR.

Remember, you read it here first.

Nov 182009

The USD has dropped pretty well back to parity with the Swiss Franc.
Based on the forex rates since 1970:
Source: Pacific Exchange Rates

This extrapolation suggests that the USD will be worthless:
– against JPY in 2018
– against CHF in 2020
– against EUR in 2042 (DEM in graph, fixed rate 1.95583 since 31/12/1998)

As the graph also suggests, the GBP, which more or less matches the USD, will become worthless in the mid 2020’s.

Of course, as any investor knows, past performance doesn’t predict anything in the future. Nonetheless it would seem that the trend will not only continue, but is likely to sharpen. The reason for this is simple; the U.S. government is borrowing and printing money at a heretofore unseen rate:
U.S. Public debt Source www.whitehouse.gov
and as every investor also knows, borrowed money has to be re-paid sooner or later.

In my opinion it will be sooner rather than later. Nearly 50% of U.S. debt is held by the Chinese and Japanese:
Foreign holders of United_States treasury securities
Source www.treas.gov
At some point the pain of holding securities whose value is continuously decreasing will exceed the perceived benefits. When that happens, U.S. creditors will start selling and the result can only be further devaluation of the dollar.

Nay-sayers will argue that the Chinese will soon have to devalue the Yuan. Maybe, but once the Yuan were to be floated, there’s no good reason for it’s value to lower, quite the opposite given their balance of payments.
The other argument is that the U.S. could raise the interest rate on the USD. In the short-term, this would certainly produce a buy signal, but in the long run this will fail, simply because the dollar will devalue more or less in step with the increasing interest rate. Let’s face it, a bond that pays, say, 15% p/a has been and always will be a junk bond, even if it’s printed by the U.S. Treasury.

As the Chinese proverb says “We are going to live in interesting times”