The concern about keeping our assets in the right currency is something that has always been a major worry for anyone with wealth or savings. In the days of the peseta, any self-respecting investor had to hold the bulk of their assets «in foreign currency», mostly in US dollars or Swiss francs. And later, with the arrival of the euro, the situation for Spanish savers became much clearer, as overnight we found ourselves with a world-leading currency right in our own pockets.
However, this sense of reassurance that our net worth was underpinned by a strong currency was short-lived. And we do not say this merely because the euro may be an expensive currency whose outlook is rather black e uncertain, not least because the world has changed so much in recent years. Today, financial markets are no longer governed by hard currencies and local currencies. The emergence of the Asian, Latin American and Russian- and Central Asian-affiliated economies, coupled with globalisation and the decline and recession of Western economies, has meant that the concept of a global reserve currency has become increasingly blurred. Furthermore, the economic pressures facing the West are leading central banks to engage in a currency war to keep the $ and the euro as weak (i.e. as cheap) as possible.
As an illustration of the new shifts that have caused the world’s economic centre to move eastwards, we would like to draw your attention to a couple of points: Recently, Australia and China agreed Direct conversion from AUD to RMB without having to go via the USD to convert it into the Chinese currency. This paves the way for the use of the yuan (and the AUD) as a leading international transaction currency. The BRICS countries (where the ‘S’ stands for South Africa joining the already familiar Brazil, Russia, India and China) are also seeking to compete with their respective currencies against none other than the World Bank and the IMF. They aim to form a united front to challenge the supremacy of the USD (and, in recent years, the EUR as well) in a global economic landscape that will soon no longer be dominated by the G8. It is no surprise that the BRICS economies will surpass those of the G8 in size within a decade or two at most.
All of these are signs that the old world, in which the US dollar was used for all global transactions – as the reference currency of the leading economic power – is now a thing of the past. The New Normal is far more globalised and dynamic than the Old Normal, and this also affects the currency in which we denominate our wealth. These days, investors should not be so concerned about the currency in which they are invested, as it is becoming increasingly difficult to avoid being affected by changes in the underlying assets. Here are some examples to illustrate this phenomenon: At present, and increasingly so, investment in companies (equities) is taking place in emerging markets. An increasing number of investment funds are including in their portfolios companies listed in Hong Kong, São Paulo, Moscow or Bangkok, which are denominated in local currencies, automatically converting them into US dollars (or euros, or the prevailing hard currency, depending on the fund class) without hedging in many cases.
What’s more, most of mid y large-cap companies (medium- and large-cap companies) listed on «Western» markets such as Wall Street, London or Frankfurt – and therefore trading in USD, GBP or EUR – are diversifying their businesses wherever there is economic growth. In other words, a very significant (and quarter-on-quarter growing) proportion of large corporations’ turnover is generated in emerging markets and in local currency. Let no one be under any illusion: even though these companies are listed in USD or EUR, its turnover is in multiple currencies. And not just its turnover, but also its production costs are denominated in multiple currencies. And more and more. Consequently, the profits or losses of the major corporations around the world, which pull the strings of the global economy, are the result of an indecipherable mix of fluctuations in numerous local currencies. Consequently, fewer and fewer executives are attempting to hedge against them using complex financial derivatives. Just imagine the currency fluctuations affecting the balance sheets of American and European companies such as Apple, BMW, Nestlé and McDonald’s.
Gone are the days when international trade was the exception, and it was therefore possible to lock in the international exchange rates for those one-off transactions so that they would not distort the outcome of the sale or purchase – and, consequently, company balance sheets. Nowadays, and increasingly so, production, sales and accounting are multinational and multi-currency. Consequently, the financial results of corporations are becoming increasingly global in nature and inherently reflect these multiple fluctuations between strong and weak currencies.
On the other hand, emerging market currencies are becoming less and less weak. In fact, it is their economies that are driving global growth, and their growth rates are saving the whole world from a depression that would be particularly frightening precisely because of its global scale. Consequently, the macroeconomic figures for the emerging world are looking increasingly positive and sound. They are creating a growing middle class. Perhaps they are achieving this by repeating the same excesses as we did, and one day they will pay the price – only time will tell – but they are undoubtedly reducing poverty in their countries by leaps and bounds. Never in the history of humankind has poverty been reduced as rapidly as it is being reduced in China, Brazil, India, Thailand, Russia and Vietnam, for example. And consequently, Local currencies are generally experiencing more contained inflation, with GDP growth and levels of public debt that are the envy of the developed world.
In short, macroeconomic figures are clearly improving. And all of this means that the currencies flowing in and out on a massive scale from the balance sheets of large multinationals and local companies are becoming increasingly reliable for international trade and investment. In fact, there is an increasing number of fixed-income issues denominated in local currency, which are attracting international investors who view them as a further option for diversifying their assets.
So, today we can find portfolios belonging to local investors, apparently denominated in euros or dollars, whose underlying assets are not what they seem. If we dig a little deeper, we will find that multiple currencies feature on the balance sheets of the companies in these portfolios, even though they are nominally quoted in USD or EUR. In these portfolios, we are likely to find investment funds holding debt issues that are either issued directly in local currency or, if issued in hard currency, are directly affected by the benefits or setbacks that fluctuations in their local currency may cause these issuers. This is because, if these issuers are governments, their revenue collection and money creation will take place in local currency; and if they are companies (not exclusively those exporting to the West), the situation is much the same.
So let’s not delude ourselves. The currency denomination of our portfolios – unless we are simply investing in eurozone debt and equities where the shares belong to companies with local operations (or the same applies to the USD) – is not as decisive a factor as one might have thought in the past. Multi-currency exposure is increasingly prevalent in the balance sheets of the companies in which we invest, and this is something we must be very clear about if we wish to secure returns that, for example, we need to spend in our local currency (EUR). If the aim is to invest at least part of our assets in the best investments on the planet, we must accept that we will be doing so in a diversified manner across multiple currencies, the fluctuations of which, for better or worse, will inevitably affect our returns. This will happen either directly or indirectly: that is, directly through funds and companies quoted in other currencies, or through the underlying assets, even though our portfolio may appear to consist solely of investment funds or shares valued in EUR or USD.
The good news is that, if we do it properly, the multi-currency mix will be such that it is unlikely that all these influences will align in favour or against us; instead, they will largely cancel each other out, resulting in a multi-directional impact on our results. After all, this may well be the best way to invest our assets in this highly globalised ‘New Normal’, because our money must go where there is growth and the best management. And we must be aware that in those places, economies are not governed by, or denominated in, euros or dollars, but in a jumble of currencies that are impossible to hedge against. We have never been such global investors as we are today, although some have not yet realised this and continue to track the performance of their investments in euros, believing that the impact of exchange rate fluctuations does not concern them.