Currency Terror!

by | Jul 24, 2001 | Archives

We have a full house for our Inspired Investing course this weekend. As we prepared my global economic update some startling and somewhat frightening economic figures appeared.

One of the objectives of this course is to figure out which currencies might be strongest over the months ahead. To do this we look at current interest rate returns, rate trends and the real returns (interest less inflation) available on various currencies.

The chart below (prepared for the course) shows the best real return now is for the British pound. The current three month yield is 5.14% and it is available in a low inflation (1.9%) atmosphere thus providing a real 4% yield. However we can learn a bit more from such analysis.

Country Currency Interest Interest Inflation Real Broad Money Current Budget
Year Ago Now Return Expansion Account Balance

Australia Dollar 6.22% 5.05% 6.00% -0.85% 6.90% -12.9 0.1
Europe Euro 4.84% 4.48% 3.00% 1.48% 5.40% - 0.3 -0.6
Britain Pound 6.09% 5.14% 1.90% 4.00% 7.40% -19.2 1.2
Canada Dollar 5.64% 4.12% 3.90% 0.22% 6.20% 22.2 2.6
Denmark Kroner 5.77% 4.93% 2.30% 2.70% -6.90% 4.3 2.3
Japan Yen 0.11% 0.01% -0.50% 0.15% 3.20% 102.9 -4.3
Sweden Kroner 4.04% 4.30% 2.70% 2.01% -1.40% 5.7 3.6
Switz. Franc 3.46% 3.27% 1.60% 1.63% 3.60% 28.3 N/A
USA Dollar 4.84% 4.48% 3.20% 1.26% 11.30% -446.3 2.1

The analysis shows that the best real returns now based on the assumption that a currency will fall at a rate similar to the difference of inflation with another currency. In other words it is assumed that since inflation is 1.9% in Britain and 6% in Australia that the Australian dollar will devalue 4.10% against the pound. However such analysis is a bit too simple so we try to see a clearer picture by looking at other economic factors such as the current account (trade balance plus investment), government deficit and money supply. The theory here is that if a country is running a negative balance this will cause the currency to fall (because the negative trade will force the country to buy other currencies thus creating an excessive supply of currency for sale). Also it is theorized that a budget deficit and or excessive monetary expansion will lead to inflation.

These factors are all early warning indicators of future inflation and weakness of a currency. So in this analysis the three best major currencies to hold right now are British pound, Danish and Swedish kroner.

This may well be because each of these currencies belong to members of the EU who have not switched from a local currency to Euro. There is a growing belief that these currencies will enter the euro block. If they do the respective governments will likely devalue to gain a competitive advantage. Thus investors may be backing off and thus higher real yields may be required to attract capital at this time.

However for the next quarter it appears that the pound and the two kroners are the best place to safely invest for maximum CD returns. But the shocking economic figures are in the dollar. I'll detail what and why this could mean in tomorrow's message. until then, good global business and investing!