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Hard Currency: A Safe Haven for the Cash Component of Your Portfolio

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In many respects I believe that the Euro will be a resilient currency and I believe that the Eurozone will be far more reluctant to devalue their currency that the U.S. and U.K. are.

Germany, the strongest link in the Eurozone chain, remembers the devastation of hyperinflation, which ran for nine years - eight years of gestation and one final year of precipitous collapse in 1923.

The German people suffered a period of hardship and real starvation as well as a permanent obliteration of their life savings. When the debacle was finally stopped, the old mark, which had once been worth a solid 23 U.S. cents, was written off at one trillion old marks to one new one of the same par value. The most spectacular part of that loss was lost in the mark's final dizzy skid; all the marks that existed in the world in the summer of 1922 (190 billion of them) were not worth enough, by November of 1923, to buy a single newspaper or a tram ticket.” Jens O. Parsson, Dying of Money

As a result, Germany will be reluctant to enter into measures which cause the Euro to depreciate significantly. The European Central Bank’s policies have encouraged citizens to save, consumers have long stopped spending and are far less interest rate sensitive compared to their U.S. counterparts. Furthermore, the recent problems in Greece and Portugal are being addressed, rather than papered over.

By contrast, policy makers in the United States remember the Great Depression. They will print money and devalue the currency at all costs, in order to avoid slipping into a deflationary depression.

While the solvency of the European banking system does raise some questions about the safety and stability of the Euro, the same could be said of the United States. My portfolio currently favours the Euro over the dollar.

Swiss Franc

Historically, the Swiss franc (CHF) has always been seen as a safe haven in times of financial crisis. When global markets are volatile, the Swiss franc normally rises as money floods into the country. Such demand for francs means that the Swiss National Bank has been able to issue Swiss franc denominated government debt at 0% interest. This is intuitive, given that Switzerland is one of the world's largest net creditors relative to its size and runs one of the largest current-account surpluses, traits that encourage currency strength.

However, in 2009 the Swiss franc fell against other hard currencies such as the Canadian dollar, the Australian dollar and the New Zealand dollar. So what happened? For one thing, the Swiss National Bank joined a handful of central banks, including the U.S, the U.K, and Japan, by undertaking quantitative easing – that is, printing money out of thin air. The new chairman of the Swiss National Bank, Philipp Hildebrand, has a reputation for advocating unconventional monetary policy, including aggressive intervention in the currency markets to keep the Swiss franc weak.

Quoting from a recent Marketwatch article published on 5th February 2010 and entitled "Swiss Franc Sinks; Central Bank Spotted Selling", "The Swiss franc fell to multi-month lows against the euro and dollar in Asia Friday as market participants said Switzerland's central bank made a rare and aggressive intervention to curb its currency. The euro spiked around 0300 GMT to CHF1.4905, its highest since Dec. 28, from CHF1.4635. The dollar jumped to CHF1.0800, its highest since Aug. 18, from CHF1.0670. Two dealers in the region said they saw franc-selling orders under the name of the Swiss National Bank on the EBS trading platform. The central bank was bidding for euros at CHF1.49, far above the spot rate of CHF1.46, they said. "I've been in the currency market for two decades, but this is my first time to see the SNB doing intervention in Asian time," said one dealer. The central bank has been talking down the franc, especially since Philipp Hildebrand became SNB president last month. It intervened several times last year, typically in the euro/franc cross.".

Another concern is the size of it’s bank liabilities. The Swiss banking system is equivalent to around 700% of GDP, not far below troubled Iceland's 900%. The risk is concentrated in two giant banks, UBS and Credit Suisse. UBS was hit by the credit crisis and if it were to collapse, it is not clear if the Swiss government could amass enough money to rescue it.

Switzerland also has high exposure to a weakening Eastern Europe. Many Eastern Europeans financed their homes with Swiss franc mortgages and the Swiss have been particularly proactive in providing temporary credit facilities to Eastern Europe.

In summary, the Swiss franc is not the safe haven it once was. The Swiss National Bank’s active efforts to talk down the Swiss franc is troubling and I remain neutral on this currency for the time being.

Norwegian Krone

The Norwegian krone is in a strong position to take over the role of safe haven currency from the Swiss franc. Norway, the fifth largest oil producer in the world, has a current-account surplus of 5% of GDP, the biggest in the industrialised world, and a budget surplus of more than 12% of GDP.

Thanks to its oil revenues it has a sovereign wealth fund worth $350bn. Norway can afford to fix any problems in its economy or banking system, and should remain stable should we face an extended depression.

While the Norwegian krone may be subject to some volatility due to the fluctuating price of oil, the stage is set for sustained appreciation.

Canadian Dollar

Canada benefits from the global reflationary efforts as its economy benefits from the rise in commodity prices - since it is a major exporter of commodities such as oil, lumber and metals, commodity price inflation actually helps the Canadian dollar.

Canada has also shown greater fiscal responsibility than the majority of other countries, bringing its federal debt down from 70% of GDP in 1995 to under 30% in 2008. Were it not for the impact of the credit crisis and resulting global slowdown, Canada would likely be running annual budget surpluses.

Canadian banks are much sounder than their U.S. counterparts, principally because their real estate market operated with more stringent standards, under which sub-prime lending was more difficult. Canada also had small exposure to the U.S. sub-prime lending market and so its banks don't have nearly as many defaults to worry about then their international peers.

On the downside, Canada’s economy is highly dependent on exports to the U.S. As a result, the Bank of Canada has refrained from tightening because it is afraid a stronger Canadian dollar would stifle economic growth. Like the European Central Bank, Canada should instead pursue sound monetary policy and avoid the temptation to make their monetary policies dependent on the U.S.

I believe that the Canadian dollar will appreciate relative to the U.S. dollar and British pound as the smart money flows towards countries with abundant natural resources.

Australian Dollar

Australia is another country, abundant in natural resources, which will benefit from global reflationary efforts. It's economy has suffered less than most and the Reserve Bank of Australia has already started monetary tightening, raising interest rates.

Rising interest rates does open the country up to a risk of a real estate crash. Having visited Australia for six weeks in 2009, I was stuck by the mania for real estate, reminiscent of the heady days of the great British property bubble.

Despite this fact, I believe that the Australian dollar will appreciate along with the Canadian dollar as capital gravitates towards those countries rich in commodities and natural resources.

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