* EZ PROFIT: Increase Earnings Through Leverage. Invest in the right currencies for safety. When you do, your money can gain extra growth and safety. At times it makes sense to leverage your potential when you borrow low and deposit high. See two case studies in this lesson. They show how portfolios designed for safety can greatly increase earnings!
Case Study #1
This first case study looks at how to increase profit from leverage.
This study was developed when this course was introduced 15 years ago.
The Mexican peso had just dramatically been devalued only three days after the President of Mexico had assured investors that the peso would remain pegged to the U.S. dollar.
This is an important lesson to remember…never trust what politicians say. Good politicians are successful in swaying the masses. The masses are always wrong so avoid where politicians lead team.
That devaluation hung heavy in economic markets, but we now know that long term the drop was meaningless. The final result was that everything moved along. The world did not implode. Economic markets did not crash.
In the early 1990s the Mexican economy seemed healthy.
Inflation was dropping. The North American Free Trade Agreement
began in 1994.
Within a year after NAFTA began, Mexico faced economic disaster. On December 20, 1994, the Mexican government devalued the peso. The financial crisis that followed cut the peso’s value in half, sent inflation soaring, and set off a severe recession in Mexico.
There many economic disturbances followed by a severe political shock when
the ruling party’s presidential candidate, Luis Donaldo Colosio, was assassinated. His death heightened fears of political instability and set off a brief financial panic that coincided with a sharp drop in Mexico’s international reserves. In about four weeks, Mexico lost nearly $11 billion in reserves.
Colosio’s assassination had other effects as well. Mexican interest rates rose sharply, and the peso depreciated. For instance, much of Mexico’s government
debt was in the form of cetes, short-term bonds similar to U.S. Treasury bills, that were sold on a regular basis. Following Colosio’s assassination, the interest rate
on twenty-eight-day cetes averaged 16.4 percent in May, 1995 compared with only 9.5 percent in February.
That devaluation was not the spark that ignited a global currency crisis. Yet it provided some great profit opportunities.
That peso fall was an important factor in one of the most dramatic short term falls of the U.S. dollar ever. When this course was originally released and this case study developed, the US dollar was at an all time low versus the Japanese yen, German mark and Swiss franc.
The peso devaluation was a stark reminder that we cannot trust what any government leader tells us about currencies. The fall of the dollar warned investors that no currency can be trusted.
Plus the pesos short term fall had a long term impact on the US dollar…and much more.
When the peso collapsed, credit card interest rates soared to over 100%. Millions of middle class investors could not make their debt payments. They lost their homes, their cars, their jobs. There was protesting, even rioting in the streets. The short term future of Mexico looked grim. This increased the flood of illegal immigrants into the U.S. and has added enormously to security and social costs in America. These added costs have increased U.S. debt which is one of the main reasons for a potentially weak U.S. dollar now.
At the same time, the lower peso ruined many U.S. and Canadian industries due to lower Mexican prices caused by the peso’s fall. Take the Florida tomato growers. They tried unsuccessfully to sue Mexican tomato shippers to stop the flow of the cheap Mexican tomatoes that flooded into Florida at prices below the Florida growing costs.
The short term thinkers saw the fall of the peso as a boon to the U.S. or other nation that were able to buy Mexican goods for less. Clear thinkers saw that economies around the world had become so related that bad news caused by a currency crash in one country is bad news everywhere.
Currency fluctuations affect you and your family daily, and they affect you more profoundly every year. As we’ll examine in this course, the US dollar has falled enormously in value and by all rights will continue to fall. This will tend to keep prices inflating. Purchases you make for your business and for your family’s livelihood will continually be affected by the international forces of foreign exchange.
The value of the dollar has fallen long term against many currencies , and as a result, at every stage of the fall foreign goods have cost more for U.S. citizens.
As the value of the dollar falls in relationship to any other country’s currency, goods from that country become proportionately more expensive when purchased in dollars. This is true for wine, bread, cheese, cars, TVs, CD players, clothing, furniture, etc.
You may say, if you live outside the United States or if you live in the U.S., but buy American, “This doesn’t affect me. I don’t buy foreign products. I buy American when I can and pay for everything in U.S. dollars.” You may think that you only spend U.S. dollars.
But the complexity of international trade and economics today makes it impossible for you to not be affected dramatically by fluctuations in the value of the dollar compared with other currencies. In addition, all you will learn in this course about what happens to currencies applies to your currency as well as the U.S. dollar. The fate of the dollar as the reserve currency is linked to the fate of all currencies.
Take, for example, a U.S. resident who purchases a General Motors car, paying U.S. dollars. Nothing could be more American than a Buick or Chevrolet, right?
But parts of every car today are produced in numerous countries. Every dollar you pay for the car is divided into segments and changed into many different foreign currencies — not by you, of course, but by someone.
You might pay $25,000 to the dealership for an American car, but several thousand of the dollars are converted to Japanese yen to pay for parts that come from Japan. A thousand or two dollars are turned to Korean won for labor and additional parts. Several thousand are converted to German marks for engineering work done in Germany. Additional thousands for design work might go to Italian lira, British pounds and Irish punts. Additional payments for engineering or labor might be sent to Canada, Hong Kong, South Korea, France, etc. And, if we go even deeper into the actual metallic, plastic and rubber components of the car, separate payments also might be sent to South Africa, Mexico, Saudi Arabia, Russia, Malaysia, Brazil, and so on.
In the end, less than one-half of the dollars you spend on this most American of products stay in America. Someone, acting on your behalf, converts those dollars into foreign currencies.
A person may say that he or she doesn’t buy many products manufactured overseas, so why worry about currencies? The above example shows why every American is continually at the mercy of foreign exchange rates. It also shows why investors have to now understand both their own currency and the U.S. dollar.
The dollar has been falling in value for nearly two decades with the result that prices of products bought by Americans in dollars are rising steadily. This has continually eroded the purchasing power of the dollar and has made many products more expensive for every American.
Automobiles are only one example of this interconnected global maze. The gasoline you use for your car or to heat your home, the clothes you wear, the food you eat, the paper you use to write on, etc., all have components produced or purchased abroad, and have increasing prices reflecting the falling value of the dollar and other currencies.
Yet in the medium term there are ups and downs that create great profits. Here is how money was made during that peso drop.
In 1995 the peso drop helped push the US dollar down to 84 yen per dollar.
The yen interest rate also collapsed. You could borrow yen for 3% and less.
The falling dollar caused the US dollar prime rate skyrocketed to 9% which meant investors could buy one of the safest investments around, US dollar ten year bonds, with a yield of 7%
So imagine an investor with $100,000 to invest. If he bought those bonds 10 year treasury bonds, he earned $7,000 a year…7% per annum. That’s a great return for such a safe investment.
If that investor used those bonds to borrow $100,000 more IN YEN, his interest cost was $3,000 a year. The loan purchased $100,000 more treasury bonds that paid $7,000 a year. The investor is now earning $14,000 a year (7% in $200,000 of bonds) and after paying the $3,000 interest, has boosted income to $11,000…11% per annum. That’s really a good return on US Treasury bonds!
The best part is yet to come.
By 1998 the yen had fallen from 84 yen per dollar to 143 yen per dollar.
When the investor borrowed $100,000 in 1995 yen he borrowed 84,000,000 yen.
To pay this off in 1998 required only about $59,000 ($59,000 X 143 = 84,370,000).
There was a $41,000 forex profit in three years.The investor over those three years earned $33,000 in interest, plus $41,000 forex gain or $77,000 total gain…ie 77% in three years or 25.66% per annum in an investment on US dollar treasury bonds.
This was the classic borrow low deposit high opportunity that we continually look for. Borrow a currency that has risen dramatically and has a very low interest rate to invest in a currency that has fallen dramatically and has a very high interest rate.
This investment was not without risk!
Had the yen risen more against the US dollar the loan could have cost more to repay. There could have even been a loss. Yet when a major currency like the yen makes numerous dramatic new highs versus another major currency like the dollar, we know that periods of high performance are usually followed by periods of low performance.
Investing in any market can be volatile. The trick is to minimize risk while retaining upside potential. Here the risk was minimized because the yen had such a dramatic rise…because the US treasury bill was such a safe investment and because the interest earned was more than double the interest paid.
Case Study #2
This case study was developed in December 2008 when the struggle between inflation and deflation had a huge impact on to diversifymulti currency portfolios.
The 14 trillion dollar per year US economy was in a position to shrinks 15%. 15% of the 14 trillion is a 2.1 trillion drawback.
Yet the US government was in a position in 2009 to borrow and spend 2 trillion dollars it did not have. This looked like balance…about two trillion each for inflation and deflation.
Historically during inflation the best investments are commodities, equities and real estate. During deflation, the best are bonds, cash (T-Bills) and real estate.
During inflation leverage works best. During deflation it is nice to sit in a no debt situation.
There were many similarities between the US economy and the US government’s response to the downturn with Japan’s slowdown in the early 1990s and the Japanese government’s response then. Readers made fortunes borrowing yen then and were in a position to do the same in 2009.
In 2009 the loans were in US dollars…not yen to borrow dollars at low rates for investing in high yield, short term dollar bonds like:
Currency Bond Yield
USD 9.125 19/05/2009 SOUTH AFRICA 6.04%
USD 10.25 17/06/2013 BRAZIL REP OF 6.24%
USD 8.25 31/03/2010 RUSSIA 5.93%
This type of bond had no currency risk if leveraged in US dollars. The only major risk was default.
Bonds denominated in euro were even more attractive because they paid higher interest and had a potential forex gain if the dollar dropped again versus the euro.
This type of leveraged investment also had a chance of loss if the dollar roses versus the euro.
There was even more yield potential in bonds denominated in euro.
EUR 5.75 02/07/2010 ROMANIA 10.81%
EUR 8.5 24/09/2012 BRAZIL REP OF 7.49%
EUR 5.25 16/05/2013 SOUTH AFRICA 8.61%
These three bonds yield an average 8.97%. They represent a diversification into Europe, Latin America and Africa. If an investor placed $100,000 in these bonds and also invested another $100,000 borrowed at 4%, the total annual return was 13.94% before any forex gains or loss.
This was again the classic borrow low deposit high opportunity that we continually look for. Borrow a currency that has risen dramatically and has a very low interest rate. Yet in the first example, the investment is not in a currency that has fallen dramatically. The investment s in the same currency as the loan.
In the second example the borrow dollar are invested in euro a currency that as fallen heavily against the dollar and has a high interest rate.
The bonds mentioned above were from Jyske Bank’s bond list. These were indicative rates not recommendations.
To learn more about current loan and bond rates like those above diversification and to check on current Jyske risk profiles, US investors should contact JGAM Thomas Fischer at firstname.lastname@example.org
Non US investors contact Jyske Bank Rene Mathys at email@example.com
In these two case studies we saw different ways to add safety. In Case One the safety was in US dollar treasury bonds. The risk was that the yen could rise verus the dollar.
In case two the safety was in short term bonds denominated in the same currency as a borrowed currency. The risk was in potential bond defaults.
In both cases there was the classic borrow low deposit high opportunity that we continually look for. The investor borrowed a currency that had risen dramatically and had a very low interest rate.
Your homework assignment is to study why the Mexican peso crashed
Also ask me questions! Your questions and my answers will form a important art of this course update. Be sure to add MCI in the subject line of your email so I will know that you have sent a question. I get over 100 emails a day so this helps me be more responsive to you.
I will not answer you directly but will include as many answers as I can in the next portion of this primer update and I will not identify you in the question and answer…so send your questions at me…no question is too minor, silly, politically incorrect or small. Fire away and have good global investing!
Join Merri, me and Peter Laub of Jyske Global Asset Management at OUR INTERNATIONAL INVESTING & BUSINESS COURSE IN ECUADOR. We review economic conditions, Ecuador real estate, my entire portfolio plus investing and business ideas for the months ahead.
Feb. 9-11 Beyond Logic.
Better still join us all year in Ecuador! See our entire schedule of 27 courses, tours, mingos and expeditions we’ll conduct in 2009 and learn how to attend them FREE.