Global Currencies – Continuing the Trend Downward
Over the weekend finance ministers and central bank governors from the top 20 industrialized countries (G-20 countries) met to discuss financial topic relating to the global economy. One of the primary areas of discussion was the recent devaluation in currencies, most recently with the British Sterling and the Japanese Yen. The Yen has declined almost 20 percent against the dollar since the beginning of the year and the British Sterling has depreciated more than 20 percent since the beginning of the global financial crisis.
The reason the central banks have been allowing their currency to devalue is that it makes their countries more competitive in the global economy and it lowers the value of a country’s debt through higher inflation. The problem with countries employing this tactic is that it has the potential to cause a currency war with each country trying to devalue their currency more dramatically than the other and the potential for high inflation and asset bubbles increases. This concern is great enough that the G-20 recently released a statement designed to cool anxieties about the potential for a currency war and in the statement they said that all the parties would “refrain from competitive devaluation.”
The question becomes what does all of this mean to investors? First, with central banks inclined to lower the value of their currency through aggressive monetary policy the likelihood for higher global economic growth becomes much greater. There is also a greater possibility for riskier assets to do well as investors continue to search for yield and are incentivized to assume more risk. With these factors it is beneficial for investors to have a larger allocation to domestic and international equities. In this environment it would also be beneficial to hold some foreign asset in US Dollars and others in the local currency. This will help diversify the risk that can come with volatile currencies including the US Dollar.
The valuation of a country’s currency can have a significant impact on that country’s economy as well as an investment portfolio so it is important to understand this risk to be able to diversify against it to limit its impact on long-term portfolio performance.