* WHAT TO DO NOW: Understand the logic of currencies. Currency swings can make profits or they can wipe you out. Nothing is more important to your investing. See why on this page.
* EZ CURRENCY SAFETY: Get managed currency funds. Gain very low volatility and EZ to use professional currency management. See page six.
* EZ PROFIT: Borrow weak currencies. Convert and invest in strong currencies. When the weak currency falls, it cost you less to pay off the loan. Learn a real example in the Case Study on page eleven.
The Tiffany lamp casts an amber glow, rich ivory and warm in the grey gloom of early dusk. The gold knobbed mahogany desk, its deep patina waxed and smooth, shines with reflections of ancient leather Chesterfields stuffed full, but rumpled with age and of maritime shots that hang in brass frames on the wall. The room speaks of settled tradition, the kind that might never end. But my thoughts instead are on the demise of this room, and how it is coming soon.
1976, London, England. Artillery Row near the houses of Parliament. After building my business in Hong Kong, I moved to London and carried on expanding there. Business grew and I opened up a new market, the United States. The pound had reached an all time low of nearly 1.5 dollars per British pound, which made the dollars from my U.S. direct mail campaigns more easily profitable.
Lured by increased sales, I left my one room office that sat over a coffee shop in Wigmore Street and moved into a five office suite of antique offices in Artillery Row and began building up a staff for expansion. We bought a computer (then a big deal). I felt very good about everything because I saw great potential in the United States.
The offices were everything English tradition could provide, balconies overlooking Victoria Street near the River Thames and Buckingham Palace, leaded frame windows, antique partners’ desks, leather couches and chairs, thick carpet and old paintings that were exquisitely framed. The office looked like it had been there forever and would stay there too until the British pound strengthened and rose 37% versus the U.S. dollar from 1.50 dollars per pound to 2.40 per pound. The fee I charged for the service I was providing was $99 per year. At 1.50 dollars per pound, I received 66 Pounds. When the pound had strengthened, the same $99 brought me 41 pounds. My business which averaged 20% profit on sales now lost 17% of sales! This was a hard and expensive lesson for me to learn. I sold the offices and left London just to stay in business. Currency changes often create more profit or loss than any other factor in business today.
As our economies become more globally integrated, we are increasingly affected by shifts in currency parities. Through this course, you can avoid learning this lesson the hard way as I did. I share more about why to understand currencies next page.
Why Understand the Logic of Currencies
Currency fluctuations may seem complicated. They may even seem random, but underneath all the complexity and apparent randomness is order and logic. There is good reason to understand this order. When reviewing investment plans and making investment decisions, it is important to under- stand this order and logic, which will help you make wise currency choices.
The economic forces behind currency values are, in their essence, rather straightforward. By the end of this course, you’ll have an understanding of why and how currency values change, how to spot the future trends of these changes, how to spot fundamental weaknesses in currencies, how you can preserve long-term purchasing power. This understanding will help you gain more safety and additional steadiness during the global currency changes that are taking place today.
Important Point to Remember. Choosing currencies wisely is of utmost importance. No other factor can cause the purchasing power of your investments to rise or fall as fast as currency fluctuations.
Have a Stable Currency Base
This course focuses on both long term, fundamental economic trends and short term technical factors that make currencies move. Before we learn this, we need to have ideas about how to take action once we do understand how currencies will move. It does us little good to know that our currency is about to fall, if we don’t know how to protect and profit from the fall. Without knowing what to do, we could know the fate of our currencies but still not know where our wealth was going to stand.
Through most of recorded history, mankind always knew where he stood in time and place because nature gave so many signals-the sun, the stars, the moon and daily, monthly and annual cycles. Mankind learned to be guided by nature.
It is a shame that modern society has lost this ability and we do not use this same natural wisdom to guide ourselves today in economics. Economics have natural cycles too, but instead of following them, most governments interfere in the natural cycles.
This interference creates so many imbalances that markets rise and fall, move up and crash in very unnatural ways. This makes it very difficult for us as individuals to know where our finances really are.
However, there are signs to know the true meaning of our wealth, signs of personal financial navigation so we can know what our investments are really worth. Despite government interference and market manipulation, it is possible to plot a course for our investments and savings.
This is especially true when it comes to choosing currencies in which to invest. This is one of the hardest decisions we can make yet the answer is most crucial to our wealth. No other factor can make our investments rise or fall more quickly than currency values. It is also unfortunate that currencies, more than any other part of economics, are interfered with by most governments.
Because choosing good currencies is a key to our wealth and because most governments use artificial means to manipulate their currency’s value, we need a personal stable currency base upon which we can fix our wealth.
This stable currency base must be a basket of several currencies! No matter how well your investments do, your wealth’s ability to purchase can be ruined if profits are made and assets are held in just one currency.
The way to attain a stable currency base is through currency diversification. This course will help you learn many ways to diversify.
Diversification is so important today because no single currency can be relied upon. We can see that the U.S. dollar cannot be trusted but this is now true of seemingly hard currencies like the German mark, Swiss franc and Japanese yen too.
For example, after the recent Mexican peso panic, investors flocked to the Swiss franc and German mark forgetting that Germany is still suffering badly from the cost of reunification and could easily suffer inflation at any time. Investors also forget that Germany is surrounded by war and instability created by the disintegration of the Soviet Union. They forget, in the haste of their panic to leave Mexico and the United States, that Germany has many crises of its own that are waiting.
Investors also forget that Switzerland and the Swiss franc are no longer islands unto themselves either. Switzerland must maintain a certain currency parity with the German mark as Germany is Switzerland’s trading partner. A steady franc-mark parity is needed by the Swiss to keep its industry going. If the German mark falters, so too must the franc. This overload into the mark could well set it up for a crash.
No currency is safe in today’s global marketplace. Until the world creates an entirely new currency system, which is currently nowhere in sight, there will always be a risk and an opportunity in each currency.
Whatever your currency of denomination, you now need a global multicurrency base. Such a base adds extra investment safety and will also increase your long term profits.
Important point to remember. In times of extreme currency strength or weakness, most investors abandon their intellect and ignore the true value of a currency. Their choices become motivated by pure greed or fear. Always avoid following such trends without reason or thought!
How to Have Global Purchasing Power
The first way to have a stable currency base is to balance your investment portfolio so that you protect your global purchasing power.
Purchasing power can best be understood by looking at a currency’s ability to buy something. Take a loaf of bread, as an example. If in one year a dollar will buy a loaf of bread and the next it takes two dollars to buy the same loaf, then the dollar’s purchasing power has fallen by 50% in terms of loaves of bread.
But understanding purchasing power is not enough! We need to extend this understanding, since we live in a global economy, to our currency’s purchasing power around the world. We buy and sell things from all over the world and need to understand the global purchasing power of our wealth.
Global purchasing power is our currency’s ability to buy things in other countries. Take buying Toyota automobiles in U.S. dollars as an example. Twenty five years ago when one U.S. dollar was worth 400 Japanese yen, a Toyota priced at two million yen, had a price in U.S. dollars of US$5,000. Today with the dollar worth about 100 yen, (assuming all other factors remain the same), the same car costing two million yen would cost nearly $20,000.
If our currency depreciates versus other currencies, so does our global purchasing power. A falling currency can ruin our wealth!
To protect the purchasing power of our wealth, we need to hold many currencies or hedge against the fall of our own. As an example, if we want to be sure we can always afford to buy Japanese imports even if our currency falls, we need to hold investments denominated in yen (or hedge our investment portfolio versus the yen). If we always want to be sure we can buy goods in Germany, we need to hold investments in German marks or hedge against a rising mark.
At least 30% of the goods and services most of us buy are imported from abroad. Thus we should invest (or hedge) 30% of our portfolios in currencies other than their own.
Thus a portfolio position with at least 30% of one’s investments held in a mixture of currencies (other than your own) should be the stable currency base from which you fix your personal financial navigation.
It is impossible for any of us to know the exact percentage of imports we buy in relation to our total spending. Even if we did, it would be even harder to know which exact currencies (via imported goods) we spend. So to keep things easy, we must make some assumptions.
One simple assumption is that 30% of the goods and services we buy are imported and that a third of these imported goods come from Europe, a third from Asia-Japan and a third from the other countries. Based on this assumption, one simple way to attain a balanced portfolio is to hold in theory about 10% of one’s portfolio in Japanese yen, 10% in ECU (European Currency Unit) and 10% in other non U.S. dollar currencies, (such as Australian dollars).
If you live outside the U.S. where more imports come from some other countries, you can use the same system above, just adjust the currencies to fit your own import realities.
Keep the other 70% in your own local currency. This position of 70% in your own currency and 30% in other currencies is your stable currency base. This is your neutral position for times when you do not have a currency view. This position today is similar to being in just your own currency 30 years ago when currencies were stable.
This neutral position is designed to equalize the global purchasing parity of your investments without risk. If your currency falls versus currencies elsewhere, the profit you make on the non local currencies you hold makes up for your currency loss in purchasing power.
On the other hand, if your local currency rises versus the other currencies in your portfolio, the additional purchasing power you gain abroad makes up for the loss in the 30% of the currencies you hold.
From this neutral base you can then speculate if you choose. If you feel that your own currency is very weak, you may choose to increase the percentage of non local currencies you hold. If you feel your local currency is going to be strong, then you can reduce the amount of non local currency you hold in your portfolio.
How to Hold other Currencies
In Lesson One, we looked at how you could use money market mutual funds to earn interest at wholesale rates in other currencies.
Now, let’s look at these funds in more detail by taking as an example a time when the U.S. dollar interest rate offered on bank savings accounts and for small CDs is about 5%. The wholesale rate for someone with hundreds of thousands or millions of dollars to place in the money market may be as high as 5.75%.
Money Market Mutual Funds are formed by investment managers so that many small investors can pool their money and place it for the higher rate in the money market.
Let’s look at an example of 10,000 investors each with $10,000 who would like to increase the return on their money and add extra safety at the same time. If these 10,000 investors pool their money with a safe fund manager, the manager has 100 million that can be placed with many institutions in the money market at the higher wholesale rate. Each investor owns $10,000 worth of all the deposits, so earns higher interest plus extra safety from the diversification of the funds.
There are mainly only U.S. dollar money market mutual funds in the U.S. Overseas there are many money market funds available in other currencies. Seven large money market fund managers were listed in Lesson One.
These overseas money market funds can be used to gain currency diversification and higher returns. Let me give you an example.
Listed below are the approximate yields that were available one year previous to the date that this course was published.
Currency Interest Rate Currency Interest Rate US $ 3.37% French Franc 6.37% British Pd. 5.43% Italian Lira 8.50% Canadian $ 4.87% Belgian Franc 6.87% Dutch Florin 5.37% Japanese Yen 2.12% Swiss Franc 4.06% Spanish Peseta 8.87% Deutsch Mark 5.93% Australian $ 4.62%
Assume for illustration purposes that one year ago an investor had $100,000 cash to place in money market funds for one year and that he placed 70% of his portfolio in U.S. dollar money market funds and 30% equally in the other 11 currencies above. Here is what his return would have been:
Amount Currency Interest Rate Return in US$ in US$ Invested Returned Before Forex 70,000 US $ 3.37 $2,359 2,727 British Pd. 5.43 $ 148 2,727 Canadian $ 4.87 $ 119 2,727 Dutch Florin 5.37 $ 146 2,727 Swiss Franc 4.06 $ 110 2,727 Deutsch Mark 5.93 $ 161 2,727 French Franc 6.37 $ 173 2,727 Italian Lira 8.50 $ 231 2,727 Belgian Franc 6.87 $ 187 2,727 Japanese Yen 2.12 $ 57 2,727 Spanish Peseta 8.87 $ 241 2,727 Australian $ 4.62 $ 125 $4,057
The investor increased his return from 3.37% to 4.05%, plus had safety from diversification. You can see this safety reflected by the enormous appreciation of many of the non dollar currencies. This diversification was important. During the year the U.S. dollar fell between 5% and 15% versus most of the currencies above. The actual return of the money market fund sector in each currency in U.S. dollar terms including interest and devaluation of the dollar is shown below.
UK Pound Money Market Fund Average 10.20% Canadian Dollar Money Market Fund Average -2.33% Dutch Guilder Money Market Fund Average 19.46% Swiss Franc Money Market Fund Average 18.32% German Mark Money Market Fund Average 19.80% French Franc Money Market Fund Average 17.77% Belgian Franc Money Market Fund Average 19.86% Italian Lire Money Market Fund Average 13.81% Spanish Peseta Money Market Fund Average 13.61% Japanese Yen Money Market Fund Average 11.40% Australian Dollar Money Market Fund Average 11.38%
In other words, in this year the U.S. non dollar portion of the portfolio rose (including interest) 13.93% (obtained by adding up all the returns and dividing by 11). This is more than four times better then the performance of the U.S. dollar money market fund.
Remember: In global purchasing power terms, the value of the U.S. dollar portion of the investor’s $100,000 fell between 5% and 15%. The rise in the non dollar portion of the portfolio simply offset the real loss of purchasing power. In global purchasing power terms, this portfolio was actually neutral.
In the future lessons we will examine how to speculate on currencies from this neutral position, so you can increase your portfolio’s purchasing power through currency fluctuations.
Now that we have looked at money market funds, let’s look at another way to diversify currencies.
Managed Currency Funds
Using Managed Currency Funds is another easy tactic that places your cash reserves in many currencies. This is especially useful for investors who want minimum fuss and bother while balancing the currency element of their portfolios. With these funds, investors don’t become involved in choosing which currencies are likely to be weak and which strong. The fund manager makes this decision instead.
Managed Currency Funds are an alternate investment vehicle for cash. The objective of the fund is to stabilize cash reserves. Here is what the prospectus of a top performing money management fund, Guinness Flight Managed Currency Fund, says about these funds:
Managed Currency Funds are suitable for cash reserves of investors who want professional management of their cash on an international basis rather than selecting among individual money market funds.
With such funds, one has no equity or interest rate risk. One has no need for currency expertise. Everything is left to the professional managers. This means that investors who wish to concentrate their attention on one or two equity or bond markets or leave all their risk money at home can put just 50% of their portfolio in the form of cash reserves into such funds. This one simple move gives global currency balance. Risk is minimized, especially if you choose only long established, safe firms and diversify among two or three managed currency funds.
Here are overseas U.S. dollar based money managed funds listed in alphabetical order. Your investigation (which I recommend) of these funds will give you a much more indepth understanding of how such funds operate.
Many of these managers also have British pound and German mark based managed currency funds. U.S. dollar based funds are for those who have the U.S. dollar as their base currency. German mark based funds are for those who use the German mark as their base, etc.
Should you use such funds, look for one in which the manager is a large, well organized and heavily capitalized company with a long standing history, good reputation and billions of dollars under management.
Allied Dunbar Managed Currency Fund, Lord Street, Douglas IM99 IET, Isle of Man, Britain. Tel: 011-44-624-661551. Fax: 011-44-624-661-2183.
AIB Fund Management, PO Box 468, St. Helier, Jersey, JE4 8WT, Channel Islands, Britain. Tel: 011-44-534-36633. Fax: 011-44-534-31245.
AXA Equity & Law Managers, Victory House, Prospect Hill, Douglas, Isle of Man, Britain. Tel: 011-44-624-677877. Fax: 011-44-624-672700.
Barclays MCF US$ Fund, PO Box 152, Rue Des Mielles, St Helier, Jersey, Channel Islands JE4 8RA. Tel: 011-44-534-67888. Fax: 011-44-534-21882.
Bermuda Intl Managed Currency Fund, c/o The Bank of Bermuda, 6 Front Street, PO Box HM1020, Hamilton HMDX, Bermuda. Tel: 1-809-295-4000. Fax: 1-809-295-8156.
Ermitage Cash Fund, 14 Bowling Green Lane, London EC1R 0BD, England. Tel: 011-44-71-251-3100. Fax: 011-44-71-251-0443.
Fleming International, 25 Copthall Ave., London EC2 7DR, England. Tel: 01-44-71-638-5858. Fax: 011-44-71-256-9205.
Guinness Flight International Accumulation Funds, PO Box 250, St. Peter Port, Guernsey, Channel Islands, Britain. Tel: 011-44-481-712176.
What to do now? Write to these funds. See how large they are. Look at their performance over the past years of currency turmoil. See if the managers also have money market funds.
History of Currency-The Dawn of Time
To better understand what currencies will do in the future, let’s go back in time and look at how currencies first began. Imagine great expanses of the European and North American continents covered with thick primeval forests. Whatever areas not covered in forest are wide barren desert, swept unceasingly by wind, frigid in winter and blisteringly hot in summer. The forces of nature rule — human civilization huddles in caves, away from wolves and ravages of weather.
On one such desolate landscape, a tribe of fifteen or twenty primitive men and women gather around a flickering fire. Fire is a new phenomenon for them. Only recently has it been discovered. The gray sunless sky reminds that winter is coming, and many of the tribal people are ill clothed.
They wrap themselves against the breeze in scant, ragged clothing they have been able to make through the summer. Their bodies shiver. For these people, the winter is one of their greatest enemies.
From the forest appears a hunter, unannounced, walking with bold, confident strides, carrying a store of pelts gathered in the mountains. His face is fierce, yet contains a spark of lively intelligence. He has a craft – that of hunting. He knows the value of his wares.
The tribal people gather round him excitedly. Before he can speak a word, they shove toward him ears of corn, sacks of grain, stones sharpened into knives and axes, and other valuables they know a hunter would not have been able to secure in the high mountains. Within minutes his supply of pelts has been exchanged.
He walks away to rejoin his people in the hills, carrying food enough and tools for the long winter months. The tribe gather again around their fire, pulling their thick new pelts around them, admiring each other and feeling secure about the coming snows.
When trade is based on primitive units of value, economic forces become simplified. Our hunter arrived at the perfect time. Winter was coming, and his goods were in demand. If, by chance, he had come down from the mountains in midsummer, when the sun beat mercilessly and the tribal people longed for a cool breeze, his arrival would barely have roused attention. His power to barter would have been weakened.
Without realizing, this primitive businessman would have fallen prey to the most elementary of economic principles governing the value of commodi- ties and units of exchange. He would have had a supply of goods for which there was no demand. In the end, even today in our complex economy, the ultimate determination of a currency’s value is supply and demand.
These forces have not changed over time. Even in today’s world of complex, interconnected currency movement and world trade, these forces remain basically unchanged.
Moving into Recorded History
It’s difficult to imagine society without a central commodity of value used for exchange of goods and services. Today if unorganized barter was the only method of exchange, chaos would reign. At the dawn of time such units of value probably were, as shown in the example of our hunter from the mountains, commodities valuable to the very existence of life — pelts, ears of corn, sharpened stones.
It’s known that oxen were used as the central unit of value in many ancient civilizations. In Minoan times, many centuries before Christ, values were consistently expressed in oxen. A slave may have been worth four oxen, a house ten oxen, a cargo of wine twelve oxen, etc. Many ancient civilizations also used cattle and sheep as units of exchange.
The word “fee” is from the Gothic word “faihu,” meaning cattle. The Indian “rupee” derives from the Sanskrit word “rupya,” or cattle.
The problems with using these commodities as central units of exchange were that some oxen are larger than others, some cows are younger, or stronger, or give more milk, or will prove more fertile. These commodities did not provide a standardized unit of value that could be exchanged quickly and without question. For thousands of years, mankind existed in a state of barter, with all the confusion and potential for deceit that barter inherently contains.
The Rise of Metals
As human civilization began to pursue agriculture, the increasing need for strong, durable tools gave rise to the first work in metals. Man moved from the Stone Age to the Age of Bronze. This malleable, versatile metal, which gained tremendous importance as the component of axes, knives, plows, and so forth, in itself rapidly became a valuable commodity. So great and so universal was the importance of bronze that it became the first universal medium of exchange.
The use of bronze dates from around 4,000 B.C. The earth’s four most ancient civilizations — India, Egypt, Babylon, and China — have all left records indicating that bronze and copper were used as currencies. Gold, though valued, was too rare and expensive at that time to be used for any purposes but jewelry among the ruling families.
However, it was common practice to cast copper and bronze molds for use as currency. The resulting bricks were not uniform in size or even shape, and were usually weighed at the time of exchange. In many countries of the ancient world, any tool made of bronze — or even small lumps of the metal — were used in trade. At the time of transaction these were stacked up and weighed to determine value. Many were even made circular with holes in the center, like doughnuts, to facilitate stacking and weighing.
The important point here is that the first currencies did not merely “represent” items of value — they “were” items of value. A small lump of bronze could be melted down and combined with other lumps of bronze to make an axe or sword. People knew how much bronze it took to make such implements, and a lump of pure bronze had definite, universal value.
Throughout history this truth has endured: the more directly tied to something of actual value a currency is, the more universal and stable its value. The simple economics of the ancient world were based on this concept. And even today, when paper and plastic money are accepted worldwide, stability can be maintained only when a currency is tied to a commodity of true value to human life. This will be discussed in great detail during this course.
As time progressed, metals became the medium of exchange in every civilization. Bronze, copper, gold, silver, and even lead were durable and could be stored for long periods of time without maintenance. They were easily transportable, and early molds of bronze and copper were often made in the form of rings or bracelets. This facilitated transportation of valuables, since rings and bracelets could be worn while traveling.
The First Coins
When people became used to settling commercial bargains by weighing and transferring metals, it was only a small step to begin production of “uniform weights of metal” that did not have to be weighed to determine value. Thus were born the first coins. Oblong coins have been found in digs in India dating from 3,000 B.C. In many parts of the world, specimens of gold, silver, copper and lead coins have been found dating from 2,250 to 1,200 B.C. Gradually, ingots came to be marked with purity and weight, and from 700 B.C. on coins were used worldwide.
Modern coinage began in the Eastern Mediterranean about 600 B.C. The Greeks coined silver money stamped with the head of an ox (showing how human traditions endure through the millennia). During the next three centuries, world trade flourished. Coins from all countries raced like great tumbling currents across the Mediterranean and Asia Minor.
Currency exchanges were established, and the increasing stability of international finance encouraged the growth of trade everywhere.
If it took man 4,000 or 5,000 years to learn how to use currencies, its governments took far less time to learn how to debase money. History is full of examples. Governments of newly founded nations usually started producing gold and silver coins of high purity. Part of the new nation’s strength was its sound money. As the society matured and began to rot within; the treasury gradually reduced the money’s purity to finance wars, debt and the personal greed of rulers.
The Greeks were responsible for introducing an innovative form of debasement. They invented plated coins, with valuable metal on the outside and base metal on the inside. These coins were discs of copper, iron, or lead, with a thin coating of silver or gold. Plating at least makes a gold coin look like gold, which it doesn’t when a high percentage of base metal is mixed in.
Rome took the practice of plating to an extreme by passing laws allowing its mints to produce one plated coin out of every seven coins produced. Within a few years, the value of Roman money fluctuated so violently that it was difficult to determine how much anything cost. A decade or so later, a Roman leader named Gratidianus withdrew the base coins and redeemed them in good “denarii.”
He was an instant public hero, receiving almost divine honors. Full-length statues were erected to him in all parts of the city. People burned incense in front of them as they would before the statue of a god. History reveals, however, that Gratidianus took personal credit for what in reality had been a council decree. Shortly afterwards he was executed in fierce political intrigue and his statues torn down.
The Importance of Stable Value
Gratidianus’ story shows how deeply the value of money affects the common person and society as a whole. People crave stability. They need it for the preservation of life. In primitive societies, stability means having the ability to stay warm (and alive) through freezing winter weather. Stability means having food and water to last through periods of drought. In primitive societies, stability is a matter of life and death.
Suppose, for instance, in the example of the hunter coming down from the mountains with his pelts, that the government of the tribes had issued low quality corn to the people. Or suppose that the government had issued hollowed-out, weak stones for the people to use as knives and axes. The hunter, examining these, would have noticed the low quality, and perhaps would not have exchanged any of his pelts. This would have put the tribe at risk of literally freezing to death in the upcoming winter.
The maintenance of monetary value is as important in our modern society as in primitive societies, but not as apparent.
In our modern society, severe fluctuations of currency values do not often result in widespread loss of life because our society today has so much wealth. But currency instability can dramatically reduce an entire nation’s standard of living.
The goods that sustain life must be produced or purchased. They do not materialize from thin air. Our society is wealthy because we have earned how to produce goods in abundant quantity through specialization. But with our society’s specialization also comes the requirement to trade and for trade to exist, currency stability is a crucial factor. This is why people still want their currency to be stable today. If the society’s currency (medium of exchange) is weak, its ability to purchase goods is weak as well.
History shows trade to be an essential factor of advanced society. History also shows that stable money is essential to trade. We can conclude that currency stability is essential to society. However history also shows that there has never been a time when all currencies were stable. There are rarely times when any currency is stable for long. In economic terms, man’s whole story can be told in terms of many currencies and their continual rise and fall.
We can conclude that the current fall of the U.S. dollar should not be unexpected nor its recovery in the long term guaranteed (though it may recover temporarily). However, history also shows that millions of investors have survived and made fortunes because of the turmoil that this continual monetary fluctuation have caused! Let’s proceed with this Case Study, so we’ll know more and can be among those who profit from currency fluctuations rather then suffer.
By Gary Scott
The British Pound Versus The U.S. Dollar
The British pound was once the reserve currency of the world, but as the dollar is doing now, it started falling steadily against other major currencies at the turn of the 19th century.
At one time, it took US$10 to buy one British pound, but it had fallen steadily so that when the Bretton Woods Agreement disintegrated in 1971, it took about US$2.50 to buy one British pound.
It then plunged all the way from US$2.50 to a low which reached US$1.00 per pound. It has since recovered back to over US$2.00 per pound and since weakened to the US$1.50 level where it has remained for more than a year at the time this course was written.
While living in London, I became very aware of this trend of the falling pound and of the fact that it fluctuated often. As mentioned at the beginning of this lesson, at one time currency fluctuations nearly put me out of business. After that time I made many investments based on the fluctuations of currencies and advised many of my clients to do the same. The results, because of currency moves were often exciting!
For example in the early 1980s, the pound had strengthened once again to well over US$2.20 per pound. At the same time, Lloyds Bank, one of the London banks I used, was just beginning to issue a new executive gold card which included an unsecured 7,500 pound line of credit.
I recommended that clients apply for these credit cards, borrow the 7,500 pounds and convert them into a hard currency for investment. Those who took that advice profited nicely. The pound fell over the next year back to US$1.40 per pound. When they took the loan, they were able to convert the pounds into dollars at US$2.20 rate and obtain US$16,500. When the pound reached $1.40 per pound, it took only $10,500 to buy the 7,500 pounds required to pay off the loan. Those investors made a quick 60% before they even made an investment! Thus they earned a return on their dollar investment plus made a huge foreign exchange gain.
There are several lessons we can learn from this case study.
* Lesson #1: Fortunes can be made just because of currency moves. In this real example, investors made 60% on the money they had at risk in just over a year, from just the currency move!
* Lesson #2: Timing is of utmost importance. In this study, investors borrowed their loans at almost exactly the right time. Had they borrowed a year earlier they would have waited much longer to make a profit. Had they borrowed later they would not have made a profit at all.
* Lesson #3: Great losses can occur because of currency moves. Any investor who borrowed pounds and converted them to dollars a year later suffered a loss. After the pound reached a low in the US$1.40 range, it then strengthened back to US1.90 and maintained that strength for several years. An investor who borrowed pounds and converted to dollars at the 1.40 rate received $10,500. $10,500 converted at the $1.90 rate would create only 5,526 pounds, a loss of 1,974 pounds or a loss just from currency moves of about 26%.
* Lesson #4: Borrowing can leverage profits or losses from currency moves. In the case study, investors made as much as 60% (or could have made a 26% loss) only on borrowed money at risk. They did not have to invest their own cash.
* Lesson #5: Interest rates are a crucial to the way a currency will move. The investors in this case study paid higher interest for the pound than they could earn on the dollars they obtained from the conversion. Generally the weaker a currency is, the higher its interest rate will be. However, if a currency is oversold, the higher its interest rate goes, the stronger the currency will eventually become.