The True Value of a Currency

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 |  Includes: EU, FXE, FXF, UDN, UUP
by: Daniel Zurbrügg
“I don’t understand currencies.” This is a statement that we hear a lot from our clients and I admit that many of the moves in global currency markets do not seem to make sense at first glance. Investors should keep in mind that there are always a number of factors at play causing moves in currency markets. Some of those factors might be very contradictory, they can interact dynamically and sometimes you even have to deal with outside market factors such as intervention by central banks. I think one of the most important lessons to be kept in mind is that one should not try to invest in currencies based on pure fundamentals (such as interest rate differentials or macroeconomic data). I think that is very important in the longer-run, but, it is also important to see how the market is positioned.
For example, currently there are a lot of short U.S. Dollar positions in the market, which might eventually cause a temporary recovery just based on money flows. But it gets even more complicated, few people truly understand all the fundamentals when analyzing currency markets. How easy this was in the old days when we still had a gold standard and you could exchange coins and bills for real gold. That’s no longer the case. The gold standard is dead and I don’t think we will ever see a comeback.
However, there are other important factors that influence the value of a currency, for example the quality of monetary policy, political stability, structure and competitiveness of an economy and degree of regulation just to name a few factors. Considering these factors, we feel that the current weakness of the Euro and the U.S. Dollar have a much deeper cause that can’t be corrected quickly. We are dealing with a structural weakness caused by fundamental distrust.
In light of this, the recent attempts to monetize debt and print more money are creating long-term damage to those currencies. The race to devalue currencies to improve the competitiveness of an economy are a fundamental mistake and the benefits of such “forced” devaluation are often overestimated not to speak of the added tax on investors holding the subject currencies. In Switzerland, our central bank has tried hard to keep the currency from appreciating further, without much success, the inflow into the Swiss Franc are too large and this speaks for the fundamental strength of our country. Of course, the strong Swiss Franc is causing problems for export oriented industries and these industries often have the strongest lobby. They will make calls for central bank intervention to protect and promote exports, but, what about the benefits of a strong currency and the increased purchasing power that results from this?
Given the global macro economic situation today, it remains highly critical to diversify currency exposures and keep strategic allocation to the U.S. Dollar and the Euro at low levels for the time being. Currency allocations should be made to hard currencies such as Swiss Franc, Norwegian Crowns, Australian Dollar and to a basket of emerging market currencies, despite being more volatile, they should do fairly well in the years ahead.
Disclosure: No positions