Fiat currencies are generally compared among themselves in order to determine a relatively stronger currency. It would however be interesting to compare fiat currencies with a hard asset to conclude on the best and worst of fiat currencies. This article compares major global currencies with gold to arrive at the conclusion on the health of different currencies.
In economics, one of the most important functions of money is that it's a store of value. It therefore makes sense to draw such a comparison to ascertain which currency is a relatively better store of value. Comparison with a hard asset also makes sense in an era of currency debasement. In general, the supply of gold can't be increased at the same pace as the supply of fiat money.
In this comparison, I have also segregated the advanced economy currency from the emerging economy currency. The inflation and growth dynamics being different, a peer comparison would yield better results.
The first chart below gives the gold price appreciation in some of the major advanced economy currencies during the last 13 years (January 2000 to April 2013).
In gold terms, the Swiss Franc has been the strongest currency in over a decade, while the pound sterling happens to be the worst currency. The dollar is the second worst with the Japanese yen closely following.
Without a doubt, readers will agree that the Swiss Franc can still be considered to be the safe haven among developed market currencies followed by the Canadian dollar. I would however like to caution investors and readers on the Canadian dollar outlook for the next few years. Going forward, economic growth might be muted in Canada with rising household debt, weak economic growth in the US and Europe and a decline in commodity prices.
If I had to predict the next ten year trend for currencies, I would be more cautious on the Euro and the pound sterling than on the dollar. I am not suggesting that the dollar will be a strong currency over the next decade. All currencies will continue to debase. Gold might have another stellar decade against the dollar with the CBO projecting nearly $10 trillion of deficits over the next 10 years. On a relative basis, investors might be better off in considering exposure to the dollar than the other two currencies mentioned. I had discussed the economic and debt problems in the UK in one of my earlier articles. Going forward, UK might be a candidate for sovereign debt downgrade and other economic problems. Also, I remain bullish on commodities for the long-term and investors can consider the Canadian dollar on correction.
Coming to the emerging economies, the chart below gives the gold price appreciation in some of the major emerging economy currencies during the last 13 years (January 2000 to April 2013).
Very clearly, the Turkish lira has been the worst performing currency. Turkey did have an inflation of over 50% in 2002. However, things have improved since then. Even today, the current account deficit problem was driving the currency lower. Among the big economies, India stands out in terms of currency depreciation. The currency depreciation on the back of high fiscal deficit and current account deficit is having an impact on consumer price inflation in India. This underscores the importance of a relatively strong currency. Among the currency picks in the emerging markets, I would certainly consider the Russian ruble. I am of the opinion that the currency is undervalued and can appreciate once the commodity markets recover. I would consider the current levels as an attractive buying opportunity. The South African Rand, which has also been among the poor performers, looks to be an attractive buy for the long-term. Investors need to avoid the Chinese Renminbi over the next 2-3 years, as growth in China might have peaked out for the medium-term.
In conclusion, all paper currencies will continue to decline against hard assets. However, as a part of portfolio diversification, investors need to be exposed to different asset classes (including currency). At the same time, exposure to certain emerging markets will give a double benefit of currency and asset price appreciation. I do expect emerging market currencies to trend higher compared to advanced economy currencies in the long-term.
I would consider certain emerging market equities as an option to invest in the local currency. Investors can consider exposure to -
iShares FTSE/Xinhua China 25 Index (FXI) for specific exposure to Chinese equities. China looks attractive at current levels. I would still take a cautious stance and gradually invest in China.
iShares S&P India Nifty 50 Index Fund (INDY) for specific exposure to Indian equities. I would like to mention here that Indian markets have rallied significantly in the last few months. Therefore, investors can wait for some correction before considering exposure to Indian equities.
iShares MSCI Russia Capped Index Fund (ERUS) for specific exposure to Russian equities. Natural resources (energy) will be the primary growth driver for Russia in the long term. The market does look attractive with a long-term perspective and can give the double benefit of currency and stock market appreciation.