During 2004 the US Dollar depreciated considerably in value
against other major currencies, principally due to low interest
rates and the gaping US budget and trade deficits. The experts,
including leading banks, predicted that the fall would continue
through 2005. They were wrong. A strong US economy, coupled
with rising interest rates helped it to regain a good proportion
of its earlier losses. The twin deficits were as bad as ever
but this was not a problem as huge inflows from Asia (purchasing
US stocks and bonds) were plugging the gap. The world still
saw the US as a safe haven for surplus cash.
Predictions for 2006 – already in question
Towards the end of 2005 experts were predicting much of the
same thing, certainly for the earlier part of 2006. The prediction
was based on the continuing attraction of US interest rates
and the still buoyant US economy. What they had not foreseen
was an announcement in early January by the Chinese foreign
exchange regulator that China was considering diversifying
its reserves away from US Dollars. This had an immediate effect
on the dollar which started to slide against both major and
Asian currencies, including the Rupiah.
So where do we go from here?
In terms of major currencies, many factors, including China’s
ultimate decision, can determine their relative movements.
China currently holds around US$250 billion in US Treasury
securities and continues to invest US$15 billion a month.
If it stops investing and starts to sell its US bonds it could
have a very negative impact on the dollar. If other countries
follow suit we could see a major fall in the currency.
What action should we be taking?
It may never happen of course and the dollar could regain
strength during the year, although the odds are starting to
mount against that possibility. The twin deficits are still
there and if there was a large scale withdrawal of money from
the US the currency could indeed fall sharply. So as a personal
investor the consideration should be one of deciding whether
to stay in USD if such a fall is possible. If you are a US
national it is not really a consideration since a dollar is
still a dollar if you return to the USA. It would just mean
that imported goods would cost you more. If you are not a
US national and do not specifically need US Dollars then perhaps
you should be asking yourself why you are holding them. Ideally,
your main currency holding should be the currency you expect
to be spending ultimately although this would not apply to
minor currencies which have always devalued over time against
the major currencies.
Are there alternative solutions?
One way to avoid the uncertainty of the currency markets is
to invest in real assets such as property or gold. These assets
hold their own short term risks but at the end of the day
they will have a face value, whereas a currency in theory
could become worthless. Investing in the stock market is another
way to protect the real value of your money. Should the USD
fall significantly this could actually help American exporters
whose stock values could then rise. So there are plenty of
ways of staying in USD while protecting against a fall in
the currency. The same principle applies to all currencies,
although sufficient cash should always be retained for short
term needs. Diversity of assets is the best strategy.
What about the Rupiah?
The Rupiah recently rose to its highest point for several
months but has since been slipping back. Reason for the relevant
short term strength has been the high rates of interest offered
by Indonesian banks and the improving economy. The downside
is that the high interest rates can attract short term speculators,
both local and foreign. At any sign of weakness they are liable
to pull their funds out and the currency can tumble. Nevertheless,
if you are Indonesian or if you have commitments in Rupiah,
for example if you are in business in Bali and employ local
staff, then it is quite appropriate to hold Rupiah as you
know precisely what your obligations are. If you are an expat
without Rupiah commitments then it is probably wise to hold
only as much as is necessary for the short term and emergencies.
Your main holdings should be in your base or ‘home’
currency. When I first came to Indonesia 23 years ago the
exchange rate was Rp.600 to the US Dollar. What will it be
in another 23 years’ time? Will I still be writing this
column? Who knows?!
Colin Bloodworth is a senior adviser with Financial Partners
International. The opinions expressed are his own. If you
have any questions regarding personal finance you may contact
him at 021 520 8099 or mail to: colin.bloodworth@financial-partners.biz
