Take the [Currency] when it Serves or Lose our Ventures

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Take the [Currency] when it Serves or Lose our Ventures

New York, June 2nd, 2015, Advisor Update®

You may remember this line from your high school English class when you read Julius Caesar. Brutus' courageous exhortation to fight a battle against Caesar's loyalists out to avenge his death had very bad consequences. For global investors, misunderstanding or miscalculating currency exposure has had a major impact on returns over the last fifteen years. For US politicians and for many in the financial media, failing to understand the role currencies play in global trade is disaster in the making.   

The sub-text for the substitution "currency for current" is instructive: both words descend from the medieval Latin currere “to run.” When currency entered the common vernacular in the 1650s, it was defined as “condition of flowing.” Many American politicians and investors realize that most assets (especially equities and fixed income) and credit indicators (interest rates and liquidity) can be manipulated. But currencies, particularly those dominating global trade today—dollar, reminbi, yen, euro—are different—they reflect the “condition” of their issuing governments’ underlying economic policies, problems and behaviors.

The debate in Congress and the financial media over the Trans-Pacific Partnership trade deal reflects this dangerous misperception. For years, an unlikely alliance of left and right leaning politicians in the US have sought to defend American jobs from what they deemed unfair trade practices; if we could stop “currency manipulation,” then the trade deficit would narrow and jobs would stay home. This ludicrous argument is a shot at Asia generally and China in particular—China accounts for roughly half of the US merchandise deficit (and has for the past decade), yet the reminbi has risen over 30% against the dollar since 1995. 

It may be good politics to appeal to baser instincts, but it masks the real problem: the US has a savings deficit which means that the US must seek savings (capital) from abroad. How do you attract foreign capital? You run large trade deficits which naturally finances whatever goods American consumers want at a competitive price.

Stephen Roach of Yale and former head economist at Morgan Stanley notes:

Without fixing its savings problem, restricting trade with a few so-called currency manipulators would simply redistribute the US trade deficit to its other trading partners. In effect, America’s trade balance is like a water balloon – applying pressure on one spot would simply cause the water to slosh elsewhere. Moreover, this approach could easily backfire. For example, assuming that there is no increase in domestic US saving, penalizing a low-cost producer like China for currency manipulation would most likely cause the Chinese piece of America’s trade deficit to be reallocated to higher-cost producers. That would be the functional equivalent of a tax hike on middle-class families – precisely the constituency that so concerns Congress. Further complications would arise from putting the verdict on currency manipulation – presumably dependent on some type of “fair value” metric – in the hands of politicians.  

This is also the twist that underscores the ultimate congressional hypocrisy. The charge of currency manipulation is nothing but a foil for the US to duck responsibility for fixing America’s saving problem. Lacking any semblance of a strategy to boost savings – not just a long-term fix to the federal government’s budget deficit, but also meaningful incentives for personal saving – US politicians have turned to yet another quick fix.

For us Global Macro investors, sorting through the noise and mistakes of politicians is an opportunity. When the US ramped up the cheap imports scheme in the early 2000s, unhedged (dollar was falling) foreign equities in developed and emerging markets were a home run. And now, with the US limping at the head of a recovering global economy, buying currency-hedged European and Japanese equities (Euro and Yen falling) has been a winning formula: 

We take the currents (and currencies) as they come to us. Cultivating political opinions that affect an investment thesis is a mistake that is very common in the US. Bad rulers and law makers enact policies that create investing opportunities, just as good ones do. The Bush II/Obama regimes and the Reagan/Clinton ones couldn’t have been more different in quality, but both sets produced plenty of investing choices. Brutus ended 400 years of republican government because he didn’t really have a plan after stabbing Julius Caesar. The next 400 years of empire were far more volatile, but somehow the modern world emerged anyway.

John Forlines III
JAForlines, LLC
Investment Management

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