Most of us are multi currency spenders. The dollar has been losing purchasing power versus other currencies for most of 40 years. This means we need to diversify our investments into the currencies that we spend.
Holding savings or investing in just one currency is a big risk.
These multi currency lessons aim to help us understand multi currency investing so our diversification will be more than just protection. Our goal is to learn how to spot fundamentally strong currencies that are more likely to maintain purchasing power in spite of global inflation.
Part of our study is of the economic pressures that affect currencies such as the price of energy and oil.
Oil’s impact on a currency divides into three aspects:
#1: The price of oil.
#2: The importance of oil in the economy of a currency.
#3: The government’s manipulation of the energy price.
Observing these three factors can gives us multi currency clues.
As a general rule, the more involvement a government has in an economy, the weaker the currency in that economy will be. Simply put, governments usually screw up! They are normally less efficient than free markets.
Let’s see, for example, how Chinese government’s involvement in oil prices could put a downwards pressure on the Chinese yuan.
Many investors believe that the Chinese currency is undervalued. If it were an over weighting of Chinese yuan in a multi currency portfolio makes sense.
Perhaps so…but there is an oil and energy twist we must consider.
China’s economic success depends on a dated Western economic model that relies on an abundant supply of three ingredients…cheap farmers…cheap energy and cheap fertilizer.
The model improves productivity by turning farmers into factory workers fueled by cheap energy. They produce cheap consumer goods…tee shirts, toys…animal food…computers…all types of stuff.
The farmers who are removed from the field are replaced by cheap energy that fuels tractors, farm implements and cheap fertilizers.
Now, two of the three ingredients in China’s economic formula (fuel and fertilizer) cost more.
China’s economy has a huge appetite for energy. Yet China imports over half of its oil.
Even worse, the Chinese government controls retail prices and is facing inflation in excess of 8%. The price of oil may seem disturbing in the U.S., but it is much more of a problem in China.
China’s domestic oil production is about 4 million barrels a day. China consumes about 8 million barrels a day and that consumption is rising at a rapid 7% a year.
China’s oil consumption is growing much faster than production.
The Chinese government plays a big role in the Chinese economy and governments are almost always less efficient than the free market.
What happens when the Chinese government interferes in the price of oil?
In most of the industrialized world, including Europe and Japan, gas prices vary dramatically. Yet the wholesale oil price is roughly the same in all those countries. The difference is in tax or subsidy.
For example, the Dutch pay almost $7.00 a gallon for gas. Gas costs $2.61. The rest is tax. The U.S. has one of the lowest taxes on gasoline of any industrialized country. Here is a general view of how the US gas price is composed:
Taxes: 11 per cent
Distribution and Marketing: 6 per cent
Refining: 10 per cent
Crude oil: 73 per cent
Japan is close to the US, as taxation pushes the gas price to about $4.50 a gallon.
Most European drivers pay near or above $6 a gallon.
Many emerging countries, on the other hand, subsidize the price of gas.
In Iraq, gas is about 40 cents a gallon…Iran less than 35 cents a gallon, Venezuela, among the cheapest at 12 cents a gallon and Ecuador $1.50 a gallon.
Chinese gas prices, which were recently raised, are subsidized. Chinese drivers and farmers pay less than $2 a gallon. This means that the Chinese oil refining industry loses billions of dollars a year.
This makes a downwards pressure on the Chinese yuan.
The Chinese government may try to raise gas prices, but it cannot afford to dampen the economic model of increasing former farmer productivity with cheap fertilizer and fuel.
This downwards pressure on the yuan is enhanced with the increased cost of improving the quality of Chinese goods. Killing consumers, dogs and kids with contaminated products is counterproductive.
Plus the Chinese must be concerned with the price elasticity of their goods. How much higher can the cost of tee shirts, toys and other cheap stuff go before beleaguered Western consumers cut back.
The Chinese economy is growing at almost 10% per annum. China has huge forex reserves and vast amounts of inexpensive man power.
Such assets strengthen the yuan…but when an essential ingredient in a formula runs dry, bigger is not always better. China’s huge, poor population offers a vast opportunity…but so far in a model fueled by cheap gas.
A transition of this model to higher gas prices could be traumatic for China and the yuan.
This means that overweighting the Chinese yuan in a portfolio is not a slam dunk for forex profit.
There is a second China warning. Keppler Asset Management rates China along with Egypt, India, Indonesia and Morocco as a poor value market.
We’ll see why next update.