Why should I invest in other currencies?
One may claim that currency exchanges are very hard to predict and so they are risky investments. This is partially true, but we all need to bet in some type of currency. Even if you have all your investments denominated in your home currency, you are betting that your currency will appreciate or at least do not devalue. In fact, even strong currencies (e.g. dollar, euro, pound, yen, franc) often lose a significant part of their value in world markets. From 2014 to 2015, for example, the Euro lost more than 25% of its value against the US dollar. From 2005 to 2015, the US dollar lost more than 30% against the Chinese Yuan. (Below you can find several recent examples of major currency devaluations).
I never or rarely leave my home country. Why should I care for currency risks? We live in a globalized world. The goods and services that you consume at home are most likely produced abroad. For example, if the dollar loses very much of its value in global markets it will be much more expensive to pay the salary of workers and general costs of producing iPhones in China, developing Nike clothing in Southeast Asia, and assembling GM cars in Mexico. To offset such production cost increase abroad, companies will have to increase the price of the goods in the US. Otherwise, it may just not be profitable to sell in the US anymore. The same happens for goods not produced by US companies but are constantly imported. For example, let’s suppose that the dollar-euro exchange rate is 1:1 and Brazil sells 1 kilogram of coffee for 1 euro or 1 dollar in the international market. If the dollar becomes weaker in relation to the euro, Starbucks will need to pay more than 1 dollar for each kilogram of Brazilian coffee, otherwise Brazil will just prefer to sell to the Europeans for 1 euro. The main idea is, if all your investments are denominated in your home currency and it drops, your purchasing power for foreign-produced items decreases. This will not only make international travel much more expensive, but also the prices of imported goods will also go up, even if you never leave your home country. In emerging markets (like Brazil and Argentina) the price of capital intensive goods, such as laptops, can sometimes double or triple in a matter of months due to the especially strong fluctuation of their currencies.
Investments denominated in foreign currencies can protect against these currency devaluations since a drop in the value of your home currency can be neutralized by currency stability in other markets. Additionally, stocks can systematically lose value throughout the world (at least in theory) but exchange rates are relative. For example, if the US dollar is depreciating against the Brazilian real that necessarily means that the Brazilian real is appreciating against the dollar. Thus, if you are Brazilian and you are thinking about travelling or studying in the US soon, you have strong incentives to buy dollar denominated investments just in case your home currency falls. The same goes for Americans thinking to go to Europe or Europeans planning a trip to Latin America. In finance this operation is known as "hedge," but it is usually done in a more inefficient way of buying currency futures that do not allow for investments and also include significant fees. If you have a bank or brokerage firm abroad you can invest your foreign currencies in other investments, like stocks or bonds. Therefore, you can potentially gain with the appreciation of the foreign currency plus the stock or bond growth. Simply buying foreign currencies in exchange houses or forex will not allow you to invest this foreign currency. The currency will be the investment itself.
Obviously, there are also risks involved as the foreign currency can depreciate. However, the more currencies you have the lower your risk will be because different currencies have different patterns. In other words, if you have a basket of currencies, the volatility of the returns will be smaller. Moreover, currencies tend to follow business cycles (i.e. cycles of economic expansion and contraction), which are unavoidable. In periods of crisis, governments tend to devalue their currencies to encourage exports and in periods of economic boom they tend to appreciate their currencies to strengthen the domestic market. Therefore, the longer that you investment, the higher your chances are to sell your foreign currency at a greater value (i.e. usually during economic booms).
A few recent examples of currency devaluations
Graph 1. US dollar lost half of its value against the South Korean Won between 1997 and 2007
Graph 4. British Pound lost about 40% of its value against the US Dollar between 2008 and 2017
Graph 5. Brazilian Real lost 83% of its value against the US Dollar between 1994 and 2019
How George Soros "broke" the bank of england
It is widely recognized within the field of political economy that governments can only pick, simultaneously, 2 out of the 3 options: fixed (i.e. pegged) exchange rate, free movement of capital (i.e. absence of capital controls), and monetary policy autonomy (i.e. control of the interest rates). That happens because some instrument must be responsible for the exchange rate(1). For example, in the early 1990’s, the UK decided to peg its currency to the German Marco. When the central bank of Germany raised interest rates, the UK could not do the same due to domestic constraints (i.e. raising interest rates increase the costs of borrowing and decrease economic activity). Then, the central bank of England started to sell reserves of foreign currencies to maintain the fixed exchange, but speculators observed that it was impossible (i.e. the unholy trinity). Foreign reserves can smooth out exchange rate fluctuation but cannot control them. In turn, investors started to bet heavily against the pound. Eventually, the bank of England basically ran out of reserves and the UK was forced to float its currency on a day known as “The Black Wednesday.” Within hours, the pound lost 10% of its value. George Soros (London School of Economics alumnus) alone made more than 1 billion dollars that day. Although rich countries' currencies can have major fluctuations as this example indicates, emerging market currencies tend to have even stronger fluctuations. This allows for greater gains in emerging market investments. Additionally, such strong fluctuations suggest that residents of developing countries have more to gain by buying rich countries' currencies (in terms of smoothing out real gains) than vice-versa.
(1) If a country chooses fixed exchange rate and monetary policy autonomy, the government must remove free movement of capital to control the exit of capital. This option can have serious downsides for the economy as investors do not like to invest in places where they cannot remove their capital whenever they want. If a country chooses pegged exchange rate and free movement of capital, the government loses its autonomy in the monetary policy as interest rates must be used to maintain the fixed exchange rate. This option also brings problems since states like to decrease interest rates in periods of crisis to encourage spending and increase the activity of the economy. Most major economies today choose to float their currencies rather than to peg them (e.g. US, EU, UK, BRICS). This option simultaneously allows for free movement of capital and monetary policy autonomy.
IMPORTANT: THERE IS NO ONE BEST TAX OR INVESTMENT STRATEGY. IT ALL DEPENDS ON YOUR GOALS, RESOURCES, AND CITIZENSHIP.
For example, are you willing to move abroad? If so, where? How long do want to stay in each place? What is your annual income? How much money are you willing to invest? Do you want short term gains or long-term investments? What is (are) the source(s) of your income? How much taxes do you pay annually? Do you want to decrease your tax duties or completely remove them? Do you feel like you want to pay some taxes even if you do not need to? What is your citizenship? Do you have multiple citizenships? Depending on each of these answers the best investment/tax strategy for you will differ. In order to see what option is best for you and to help with the implementation of the strategy feel free to reach out to us. You do not need to be rich to create a global investment portfolio. Most of the bank and brokerage accounts we open do not have minimum initial deposit or maintenance fee. Thus, you can invest as much as you want or even leave the accounts empty until you have enough capital or interest to invest abroad.