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Editor’s Note: In today’s Weekend Edition of the Palm Beach Daily, we’re pleased to welcome back Palm Beach Research Group’s Editor-in-Chief Jeff Remsburg. Today, Jeff exposes a currency crisis affecting the entire world, and what you need to do to protect yourself from becoming its next victim… |
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Right now, governments around the world are involved in a war that most investors don’t fully understand…
That’s a problem—this lack of understanding can be dangerous to your wealth.
You might have heard the term “global currency wars” recently. But while this term might be familiar, it’s likely not occupying much of your thoughts.
I understand. The idea of a global currency war feels abstract—peripheral to things that really affect you and me on a day-to-day basis.
But that’s not actually true.
The actions of global governments are, in fact, putting your wealth in jeopardy.
So while these currency wars aren’t cause for panic, we do need to understand the issues and act wisely in order to safeguard our wealth.
Today, let’s clear up the mystery around these currency wars… then discuss what you can do right now to protect yourself from becoming a victim.
Why the Foreign Exchange Market Matters to You and Me
Most times, when we say “the market,” we mean either the stock or bond market. But the largest market in the world—by far—belongs to the “foreign exchange.” This is the global market for trading world currencies.
Just how big is it? Well, foreign exchange trading averages out to around $5.3 trillion… per day.
Of course, that’s impossible to visualize. The chart below lends some perspective. Notice how it dwarfs the size of the New York Stock Exchange…
“Okay,” you say. “So the forex market is huge. So what?”
Well, the events in the forex market directly affect the value of your U.S. dollars. And the value of these dollars impacts your ability to buy more or less of the products you want. So, the forex has a direct influence on your wealth—whether you realize it or not.
Let’s look at a simple hypothetical…
Say your child wants a Sony PlayStation video game console. So do the children of millions of other American parents. To meet this demand, the purchasing manager at Best Buy negotiates a deal to buy millions of PlayStations.
Now, let’s assume the purchasing manager and Sony negotiated their price in yen. In that case, the purchasing manager doesn’t just mail the Sony headquarters in Tokyo a check in U.S. dollars. He has to convert his U.S. dollars into Japanese yen. In essence, he first “buys” yen with American dollars.
To keep things simple, let’s say that at the time of the PlayStation sale, $1 buys ¥100.
Now, remember the Economics 101 lesson of “supply and demand.” Because the Best Buy purchasing manager needs yen to buy the PlayStations, there’s suddenly increased demand for yen. What happens when there’s more demand for something? Well, if the supply doesn’t change, the price goes up. In this case, the “price” that’s going up is the price of yen.
Make sure you understand what’s happening here. I picked Sony PlayStations for our example. But I could have chosen a Honda CR-V, a Nikon camera, or a Hitachi TV… The actual product doesn’t matter.
The root issue is that the purchase of any of these Japanese products will eventually lead to a currency conversion—U.S. dollars “buying” yen. And that increases the demand for yen, and therefore, its “cost.”
Back to our hypothetical…
The demand for PlayStations (and, subsequently, yen) has gone up. As a result, the next time the Best Buy manager places an order for PlayStations, then goes to exchange dollars for yen, something’s changed… $1 no longer buys ¥100. It buys only, say, ¥90.
That means the Best Buy purchasing manager now has to pay more U.S. dollars simply to receive the same volume of PlayStations. In other words, PlayStations just got more expensive for Best Buy.
And if Best Buy starts to lose money because of this for an extended period, guess who’s likely to help shoulder the added cost?
The consumer—you and me.
Global Currencies Are a Zero-Sum Game
There’s a dynamic in our PlayStation hypothetical I want you to catch…
When the yen became more valuable, what became less valuable?
The U.S. dollar.
Notice how that works: Currency values are generally a zero-sum game. In other words, if we have just two currencies, A and B, Currency A can become more valuable only if Currency B becomes less valuable.
Right now, the U.S. dollar is very “strong.” This means it takes more units of foreign currencies to buy a single U.S. dollar than it did, say, six months ago.
For example, see the chart below. It tracks the U.S. dollar relative to the euro over five years. Note the drop starting in 2014. It intensifies in the last six months or so. This is showing us how it’s taking far fewer dollars to “purchase” a euro.
A strong dollar is great for U.S. companies that import their goods. (It takes fewer U.S. dollars to buy the same amount of foreign goods.)
But a strong dollar is bad for U.S. exporters. (Global buyers have to pay more of their own currency to convert to the “strong” U.S. dollar.) This makes U.S. companies less competitive on their pricing.
Are you noticing how the world suddenly seems much smaller?
Foreign currency policy connects our globe in a way that often affects you and me on a personal level—even though it’s not front and center to us every day.
All This Leads Us to Right Now—the Global “Currency Wars”
Okay… where does this leave us with the “currency wars” we’ve been hearing about in the news recently?
Well, we’re witnessing a colossal effort by governments all around the globe to weaken their currencies. They’re doing this in an effort to ignite sputtering domestic economies.
To see how this works, let’s revisit our hypothetical above…
We started off saying $1 buys ¥100.
But now, let’s say the Japanese government weakens the yen. So $1 actually buys ¥150. This means the Best Buy purchasing manager needs fewer U.S. dollars to “buy” all those PlayStations. This encourages more sales. Walmart and Target decide to place orders for these “cheaper” PlayStations too.
So we see more U.S. dollars flow toward Japan—therein boosting the Japanese economy.
But remember—currency wars are a zero-sum game. Winners come at the expense of losers…
If the yen falls that much in value, the “loser” is the American business that earns most of its revenues from exports to Japan.
You see, the high cost of the U.S. dollar in yen means Japanese buyers can’t buy as much of the American business’s product. It takes too many yen now to buy those strong U.S. dollars. So business slows… The U.S. company has to lay off workers… Those workers now don’t have the income to buy goods and services here in the U.S…
Just a month and a half into 2015, we’ve already seen more than a dozen central banks inject stimulus money into their economies. (This is one of the preferred methods governments use to devalue their currency.)
So what happens when every currency is trying to be the least valuable? Well, we’re in the middle of finding out—but, theoretically, the answer isn’t good for you and me.
In a true currency war, Country A devalues its currency to boost exports, as I just wrote. But then, Country B retaliates. It devalues its currency even more. Country A fights back. Then B. It creates a death-spiral of devaluations. Businesses choke.
So… What can you and I do about all this?
Your Best Defense Against Currencies—Gold
The answer is simple: Make sure you own gold.
Historically, your best bet against currency manipulation is owning gold and hard assets (think land or timber). The reason is, you can’t “print” more gold as you can a government currency. There’s limited supply. This helps preserve its purchasing power.
We suggest gold as a “chaos hedge” in the Palm Beach Research Group Asset Allocation model. You can click here to review it. Mark has also written at length about how he views gold as a valuable form of insurance.
Now, here’s what makes the case for gold all the more interesting…
Right now, we’re seeing gold demand distort traditional market forces. This is significant.
Historically, the U.S. dollar has moved opposite the price of gold. (When gold is up, the dollar is down, and vice versa.)
The chart below shows a U.S dollar Index relative to gold from 2001 through mid-2014. Notice how U.S. dollars and gold tend to have counteraction.
What’s interesting is this typical counteraction hasn’t been happening recently…
From its mid-2014 level to this past January, the general trade-weighted dollar jumped 10%. That’s the fastest six-month gain since 2008. Despite this, the price of gold has generally held steady.
This is not normal pricing behavior.
Julian Jessop, chief global economist at Capital Economics, recently commented on this irregularity…
This latest episode [involving gold’s price] is all the more remarkable given the strength of the U.S. dollar. On the basis of the past relationship between the two, the price of gold might now be expected to be touching $1,000.
Instead, even as the dollar hit an 11-year high against other major currencies in January, gold hasn’t dipped much lower than $1,200.
Why Is Gold Acting Differently Now?
As governments around the world fire up the printing presses to fight the “currency war,” it’s scaring global investors. They see the value of their currency—therefore their own wealth—declining.
So they’re turning to gold, the historic safeguard of wealth. This is providing a support for the price of gold—even though it shouldn’t exist right now (by historic standards).
Now, let’s be clear…
I am not preaching doom and gloom. This is not the end of stocks. And I’m not predicting gold at $2,000 next month. But, this is a reminder that every balanced portfolio needs the security that gold offers.
Plus, when you see gold’s price behave in a way that’s not consistent with historic market forces, it’s worth taking note. It’s often an indicator of a bigger move to come.
Bottom line: Today, we shouldn’t fear these “currency wars.” But make sure you understand them, and then be responsible. Make some room in your portfolio for gold.
Jeff Remsburg
Editor-in-Chief, Palm Beach Research Group
Is gold in your portfolio? Don’t miss Mark’s take on gold in the March edition of Creating Wealth (coming this Monday). And please give us your feedback on Jeff’s essay, right here.
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