Profits in a forint crash

by | Dec 5, 2003 | Archives

Now may be the time to reduce holdings of Hungarian forints, but a time may come when investing in them will present a bargain.

Here is what happens to the multicurrency sandwich if the Hungarian forint crashes and is oversold versus the Euro and Swiss franc, but keeps its high interest rates. Assume you already have a US$100,000 bond that you use as collateral to borrow $400,000 of Swiss francs at 1.875%

Amount                 Investment                    % Earns       Amount
$100,000 US$ bond 3.5% $3,500
$400,000 Hungarian Forint bonds 12.5% $50,000
$400,000 Swiss franc loan 1.875% $7,500

Positive Carry Profit Potential in one year $46,000

This is a high risk investment without a doubt. So are US dollar AAA bonds that pay 3.5% when the US dollar is crashing. The upside on the dollar bond is 3.5%. The upside on the sandwich position may be 100%. Look at the risk and the potential reward before making a decision. Risks include the franc interest rate rising, defaults on the Hungarian bonds, a higher forint interest rate and most of all further decline in the value of the forint to the Swiss franc.

The upside potential is substantial. If the forint rise’s in value to the franc, a forex profit can be enjoyed. If forint interest rates fall or the quality of forint bonds improves, capital profits can be made.

Now let’s look at why beyond the fact that the interest rate is very low we would borrow Swiss francs.

Investors have been making a mistake that we have warned about for nearly a decade. These mistakes could create opportunity for you. They continue to think of the Swiss franc as a super strong currency. This is no longer true!

Years ago in a different world Switzerland was isolated and fiercely independent. Their mountainous terrain and well organized citizen's army gave them the strength to claim and enforce neutrality.

The small population (about 6 million) believed in personal and hence banking privacy. The people were incredibly conservative and highly efficient. They did not believe in government debt and demanded that their national bank keep a large amount of gold as a reserve for their currency. This made Switzerland an ideal banking center in those days plus made Switzerland a refuge in times of turmoil. Swiss francs in a Swiss bank account were considered one of the ultimate forms of financial safety.

This all changed. The computer, new tactics in war and the global economic community turned everything upside down. The computer was like the Colt .45, a great equalizer, making bankers in England, Italy or Spain etc. as efficient as the Swiss. New instruments of war, intercontinental and cruise missiles, nuclear weapons, etc. dramatically reduced Switzerland's natural defenses.

Most of all, the global economic community forced Swiss banks to deal in US dollars, British pounds, Japanese yen and German marks. Swiss banks had to open centers abroad and hence became vulnerable to other country's law. They lost much of their independence!

Today Swiss banks such as Credit Suisse are affected by what happens in the US and other countries (they have a huge investment in their subsidiary Credit Suisse First Boston). More importantly the Swiss Franc can no longer be allowed to be the reserve currency of last resort. Switzerland is a poor country in terms of natural resources lacking oil, minerals and the ability to feed itself. Switzerland is a trading nation and must have its currency at parity with other nations which allows them to export goods. It must export to survive. Half of its exports go to Germany. When the Swiss franc becomes too strong, especially against the German mark or now the Euro the Swiss act quickly to force its parity down. The last time the Swiss franc rose too high the Swiss imposed a 12% per quarter negative tax on Swiss franc accounts held by overseas investors.

Switzerland is a good banking center, yes. The Swiss franc is a strong, stable currency, yes. Yet the Swiss cannot afford to let the franc rise too high.

I have shared this information for at least the past six or seven years, maybe ten, warning not to invest too much in Swiss francs when it is strong, so what I am writing here is not something new. However much of the investing world always runs five to ten years behind!

Here is the point. The Swiss franc is linked to the euro because the Swiss have to remain competitive so they can export. Hungary is joining the Economic Union. This means that their currency is linked to the euro as well. If the forint becomes too weak, goods manufactured in Hungary will become overly competitive to goods manufactured in Switzerland. Understanding this is currency investing at its best.

This is no guarantee that a Swiss loan invested in Hungarian forints will reap a huge profit. But it does mean that many fundamentals are leaning that way, plus always remember that when there is positive carry (the investment brings more than the cost of the loan) we get paid a guaranteed return to take the risk, plus may make more profit (or loss)

I lack time and space here to explain the Borrow Low – Deposit High and other diversification tactics n depth , but feel these issues are so vital that I urge you to read the free correspondence course International Currencies Made EZ at

Until next message, good international investing.