The Dollar and the Currency Carry Trade

You would think that after Bernanke talked up the American dollar and the Saudis agreed to boost oil production, the U.S. dollar would go up. You would be correct. See the June 10, 2008 chart for currencies.

But for American investors still shell-shocked by the dollar’s decline, is now a good time to jump into the foreign currency pool? Probably not. While I own some shares of a Swiss francs ETF (FXF), I will not buy any more. There are so many other ways to get foreign currency exposure it makes no sense now, after the dollar’s steep decline, to buy other currencies directly. The U.S. dollar might keep increasing, or it might decrease in value–there is no sure way to determine which way the trend is going now that the federalis have finally awoken and removed their muzzles.

So what’s an investor to do? My pick is the PowerShares DB G10 Currency Harvest (DBV). (Disclosure: I own some shares of this unique ETF as a currency hedge, along with my FXF.) Basically, DBV is one manifestation of the “currency carry trade.” DBV borrows low-yielding currencies and lends (buys) high-yielding currencies; theoretically, returns should be automatic, assuming only slight variations in interest rates (and yes, that's a major assumption).

Making these kinds of trades in a personal FOREX account would be too complicated and time-consuming, and that’s why DBV is an interesting product–as an ETF, it carries a low fee, and it further hedges its risks by using only ten fairly stable currencies, including the Euro. Any diversified currency product with ample exposure to the Euro is beneficial, at least to hedge a personal portfolio. As Dallas Fed Reserve President Richard Fisher told me at the Commonwealth Club, the ECB has only one mandate–to fight inflation, which makes it more politically palatable to maintain higher interest rates, leading to a more stable currency.

DBV is selling for 26.78, and FXF is selling for 95.93 as of the close of business on June 10, 2008. But if you don’t like DBV and you don't like the idea of dabbling in currency products, you’re in luck. Almost every major DJIA-listed company derives much of its revenue from overseas. Even Pfizer (PFE) has substantial currency exposure because of how much cash it has abroad. But General Electric (GE) would be my pick of the bunch if you are looking to buy a multi-national conglomerate with overseas exposure–it is at a five year low, and as of June 10, 2008, yields around 4%. That’s hard to beat when money market yields are around 2%. (Disclosure: I own GE and PFE.)

I hope that the federal government soon heeds President Eisenhower’s prescient words: “to support progress in our country, and indeed throughout the free world, we must make certain that there is no cheapening, no debasement of our currency” (Presidential Reflections, 1960). Until the Federal Reserve starts raising interest rates, I will keep looking for ways to protect myself from a government that seems to openly disrespect savers.

Comments

[theinvestingspeculator]

Enter your comment hereJim Rogers thinks the carry trade is over for the yen and that it will start going up. See what other currencies he likes @
theinvestingspeculator...

[SA2]

Beware!

DBV has some very nasty tax implications including, but not limited to having to submit a K1 form to the IRS.

I held it for a while, made no gain and had to pay taxes as if I made a significant amount of profit.

SA.

[MatthewRafat]

SA: thank you for your useful comment. I hold DBV in a Roth IRA, so I did not consider its tax implications.