Worried about savings in Euro - should I be?

Duke of Marmalade said:
You recommended to "bet into" the currency of a AAA rated country. Germany, France, Luxembourg, Netherlands and Finland are all AAA rated. Their currency? The Euro.
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Exactly, but not on one unique country... I would propose a proportion with the formula of GDP in weight of the AAA countries to spread the savings wisely... I wish I could do it but I can't fly so much to open accounts...

In my opinion as soon as we go the parity of currencies in Europe the AAA rated countries will gain versus other countries like Greece, Italy, Ireland, Portugal. Again just an opinion....
 

Hi Marc,
I replied to that post before (http://www.askaboutmoney.com/showpost.php?p=1178022&postcount=25). You are basically cherry picking a time to achieve results that suits your argument. Just go 2 years earlier, which coincides with the actual introduction of the Euro, and the entire picture changes:
EURCHF: 1999: 158 current: 120
EURCAD: 1999: 170 current: 140
EURJPY: 1999: 130 current: 114
 
Chris,

I am not making the point that some currencies won't beat the Euro over some period of course some will win and some will lose.

I am making the point that "investing" in currencies is a bad idea per se.

They are not a safe haven since they are volatile and the relative performance of any currency against any other currency is just a random walk.

You don't know in advance if a currency is going to win/lose/or draw against the Euro and presenting data that shows the Swiss Franc has increased by 2.26%pa against the Euro is just as misleading as saying that the British pound has lost 1.66%pa between Jan 1999 and May 2011 against the Euro.

What we want to know is what are currencies going to do in the future? Of course nobody can answer that so all we can really say is that over a reasonable period of time (ie since Jan 1999) currencies have shown good and bad performance against the Euro but for a conservative investor worried about their savings betting on currencies is a very bad idea.

I have frequently read comments on AAM and in the press suggesting currencies as a good way to protect against the Euro and a safe haven. This is extremely poor and should be addressed in a way which highlights the downside as well as the upside.

In my post I simply highlight the fact that despite all the talking heads claiming the safe haven status of this or that currency, investors could have lost considerably.

Lowest one year returns (Jan 1999 to May 2011) vs Euro
Aussie Dollar -18.52%
Sterling -23.86%
Canadian Dollar -16.33%
Swiss Franc -7.38%
US$ -20.56%
 
Hi Marc,

my opinion: key factors as we don't have a christal sphere:
- diversification: a bit of gold, a bit of strong currencies etc
- the fact that S&P, Moody & Co. have incredible power in influencing decisions: for example AAA countries give a bit more reliability than junk-rated countries
- and in my opinion pls let's not look too much at the past to influence future decisions... Otherwise we would all win in the stock exchange...

All the best
 
But you selectively chose currencies and the period to show a negative return and used this to argue that investing in currencies is a bad idea. Now I don't disagree that currencies are not for everyone, especially given their volatility, but that doesn't mean they should be dismissed as a bad investment.


Yes it is misleading, which is why I posted a different time frame for different currencies to make exactly that point. However, when you look at the central banks' behaviour of currencies that have gained vs. lost against the Euro you very quickly see that the strong currencies are less inflationary, and also have economies behind them that are less indebted and more productive. It is not random noise. Now of course it could all change, but I have more faith in the SNB to curtail monetary inflation than I do in the BoE or ECB.

For someone that has repeatedly referenced a policy of long term investment this is a very surprising post. All this post does is highlight volatility. If people had lost out in these instances then they would not have been investors but traders. Investors in strong currencies (low monetary inflation, low level of debt, highly productive export economy) like AUD, CAD and CHF would still have been good investments despite significant volatility.
 
Chris,

I am highlighting the volatility since this is all you have from a currency. They are not an investment. An investment has a positive expected return.

I have put some more data on this subject on my website.

[broken link removed]

In a sample of 20 currencies against the Euro from Jan 1999 to May 2011 the best performing was the Malaysian Ringgit!. How many of us predicted that back in 1999?

Again, I repeat. There will be some currencies that will win relative to other currencies. But the challenge here from an investor's point of view is attempting to identify which will be the winning currency in the future. In an efficient market, all of the examples you put forward (low inflation, low debt etc) are known in the market. This is not inside information that offers you a free investing lunch.
[FONT=&quot]
[/FONT]Do fiscal deficits lead to currency depreciation?
No. It is commonly believed that large fiscal deficits and high debt cause a currency to depreciate as the government borrows more from foreign sources, and investors who are concerned about inflation and default risk flee the currency. Although recent developments in the US would seem to support this relationship, there is less convincing long-term evidence that deficits affect currency rates. During the 1970s and 1980s, the dollar strengthened while the government increased deficit spending. This observation is consistent with academic studies concluding that exchange rates appear to move randomly, and there are no models to date that can reliably forecast currency returns.

Do higher deficits hamper economic growth?
It depends on a country’s debt level. Using World Bank data from 1991 to 2008, we compared current deficits to future GDP growth in sixty-seven countries and found an increasing interactive effect between deficits, debt, and economic growth. High-debt countries that run deficits are more likely to experience lower economic growth over the next three years. But numerous forces may affect a country’s economic direction, and deficits explain only a small fraction of the variation in future GDP growth. The combination of high debt and deficits can create headwinds for economic expansion, but slower growth is not guaranteed.

You can't infer that a low debt, low inflation country will lead to a good investment from a currency perspective simply because the currency follows a random walk based on FUTURE news events which by definition are not predictable.

What the data shows is that you are exposed to additional volatility from currency risk, and that you are rarely rewarded for this additional risk compared to an investment in short-term money market accounts.

Investing in currencies carries risk, investors are not rewarded for this risk, since they can diversify it away (or hedge it with a forward contract).
 
Marc, I'm with you all the way.

Though I do know a professional currency trader who is adamant that there are arbitrages out there due to some players simply not being too concerned about small variations. I think the example is some Airline needs 500M dollars to buy an airplane, they don't really care if they miss 10bps.

I remain skeptical, but in any event for the retail investor there is no way that there is a good choice of currency (other than the one their expenses and liabilities are denominated in) and anyone who recommends people to go into this or that currency is a spoof merchant.
 

Well, we do disagree on the efficient market hypothesis, which would explain a large part of our disagreement on the topic of currencies, and I don't think there is anything gainful to this thread from discussing it further. But I do believe that fundamental investment analysis can be applied to currencies, just as it can be to equities.
 
Chris

You are correct in the sense that fundamental analysis can be applied to currencies the key though surely is can an average retail investor profit from it?

Many people will be aware of the concept of the carry trade which seems to quarrel with the concept of market efficiency in currency markets. But the reality of this is like NassimTaleb describes options trading; "you eat like chickens and go to the bathroom like elephants".

I don't believe that the "average" retail investor has a sophisticated enough algorithm, and/or the trading capacity, and/or the volumes to obtain sufficiently competitive trades in order to profit from any arbitrage opportunies in the FX market.

A recent article in the Wall Street Journal lends some weight to this view.

Not only are would-be currency speculators playing against a "stronger opponent", they are playing at a disadvantage.

The brokers on whom individuals rely to conduct their foreign exchange trades typically trade against them. Unlike stock trades, there is no requirement of “best execution” on currency trades. Typically, a retail foreign-exchange dealer is usually on the other side of the trade and this same party quotes the price. Although the conflict of interest is disclosed in the contract signed by individual currency traders (who now account for about $315 billion of daily trading volume), the overwhelming majority of them are simply not aware of it. One typical disclosure cited in the article reads as follows:

"Your dealer is your trading partner, which is a direct conflict of interest. The dealer may offer any price it wishes, may show different prices to different customers, and the prices shown might not reflect prices available elsewhere."

So, the foreign exchange market may be inefficient, if one means that it is inefficient for you to attempt to profitably trade in it!

This is a good paper on the subject by Pasquale Della Corte * Lucio Sarno * Ilias Tsiakas 18 January 2008

The forward premium, the difference between the forward exchange rate and the spot exchange rate, contains economically valuable information about the future of exchange rates. Here is the evidence that it can help predict short-run rates and that investors who ignore it and use random walk models may be leaving money on the table.

Exchange rates are important to innumerable economic activities. Tourists care about the value of their home currency abroad. Investors care about the effect of exchange rate fluctuations on their international portfolios. Central banks care about the value of their international reserves and open positions in foreign currency as well as about the impact of exchange rate fluctuations on their inflation objectives. Governments care about the prices of exports and imports and the domestic currency value of debt payments. Markets care both directly - the market for foreign exchange is by far the largest market in the world – and indirectly, since exchange-rate shifts can affect all sorts of other asset prices.

No surprise then that forecasting exchange rates has long been at the top of the research agenda in international finance. Still, most of this literature is characterised by empirical failure. Starting with the seminal contribution of Meese and Rogoff (1983), a vast body of empirical research finds that models which are based on economic fundamentals cannot outperform a naive random walk model (i.e. the exchange rate is, at any moment of time, as likely to rise as it is to fall). Therefore, the prevailing view in the international finance profession – shared in academic and policy circles as well as in a large fraction of the practitioner community – is that exchange rates are not predictable, especially at short horizons. In academic jargon, exchange rates are thought to follow a random walk.

A Random Walk?
At first glance, the random walk model makes a lot of sense. The person on the street knows that movements in exchange rates are often hard to explain and is reluctant to believe that fundamental forces are at play. Exchange rates often swing wildly on a daily basis for reasons that apparently have little connection to economic and financial variables. Even worse, they often move in the opposite direction of differences in short-term interest rates across countries. Despite its simplicity, therefore, the random walk model remains appealing because it leads to smaller forecasting errors than most other exchange rate models.

The horse race
This conclusion is based on a ‘horse race’ between the random walk and theory-based predictions. In this race, the random walk always wins. Our recent research argues that this is not the end of the story, but explaining our point requires something of a detour – an explanation of the ‘horse’ that classic exchange rate theory says should be winning the race every time.
The cornerstone condition for efficiency in the foreign exchange market is ‘uncovered interest parity’, i.e. the exchange rate jumps to the point where risk-neutral investors are indifferent between holding any two currencies. As a matter of accounting, the difference between the rates of return on the two currencies is the interest rate gap plus the expected appreciation; if the 12-month dollar interest rate is 5% while the 12-month yen interest rate is 1%, then, according to the theory, markets must expect the yen to appreciate 4%. If this isn’t true, why would investors hold yen?

As logical as this seems, the relationship does not hold in the data, as the famous “Fama regression” (Fama, 1984) showed. One relationship that does hold in the data is the so-called covered interest parity, which states that the interest rate gap equals the premium on forward contracts. That is to say, if the dollar-yen interest rate gap is 4% as in the example, the forward contract for dollar-yen will imply a 4% premium over today’s exchange rate for yen. Indeed, that is basically how banks set forward rates. The Fama regressions put together the uncovered and covered interest parities to check whether the actual exchange rate follows the forward premium. In the example, the question would be whether the actual appreciation of the yen over the next 12 months was 4% (plus or minus some white noise randomness due to unforeseeable events). Decades of research on masses of data by dozens of scholars show that the actual appreciation does not follow the forward rate. Indeed, it is the currency with the high interest rate that tends to appreciate, not the one with the low interest rate.1

This is stylised fact that is so well known that it has a name, the “forward bias puzzle,” namely high-interest currencies tend to appreciate when uncovered parity predicts depreciation. While troublesome for economic theory, this puzzling behaviour may be valuable to investors.2
As mentioned, the horse race between pure randomness and uncovered interest parity always goes to randomness. But what happens if we let a new horse enter the race? What happens if we assume that investors ignore the pure theory and instead work off the empirical fact, i.e. the forward bias?

Valuable Predictions
In recent research, we examine whether exchange rate predictability could translate into economic gains for investors using an asset allocation strategy that exploits this predictability (Della Corte, Sarno and Tsiakas, 2007). In particular, we assess the economic value of the predictive ability of empirical exchange rate models that condition on the forward premium in the context of dynamic asset allocation strategies.3
We focus on predicting short-horizon exchange rate returns when conditioning on the lagged forward premium. But statistical evidence of exchange rate predictability in itself does not guarantee that an investor can profit by exploiting this predictability. We therefore evaluate the impact of predictable changes in the conditional FX returns and volatility on the performance of dynamic allocation strategies. Ultimately, we measure how much a risk-averse investor is willing to pay for switching from a dynamic portfolio strategy based on the random walk model to one which conditions on monetary fundamentals, the forward premium or a broader set of variables, including the money supply and income differentials across countries.

Our work suggests that these exchange rate predictions are valuable. There is strong economic evidence against the naïve random walk benchmark with constant variance innovations. In particular, the predictive ability of forward exchange rate premia has substantial economic value in a dynamic allocation strategy. In addition, conditioning on a forecast of future volatility given current information, rather than assuming that volatility in the foreign exchange market is constant, further enhances the predictability of exchange rates and increases risk-adjusted profits.

Conclusions
There’s money to be made in the world’s biggest market. Our evidence suggests that investors using sophisticated models could make informative exchange rate predictions and considerably outperform the random walk benchmark. Those trading currencies may find it worthwhile investing in a model using the forward premium and dynamic volatility. Policy makers can also find some comfort in these results since predictability in the exchange rate would allow them to better gauge the value of their international reserves, their debt positions, and their competitiveness in international goods markets.

References
Della Corte, P., L. Sarno, and I. Tsiakas (2007). “An Economic Evaluation of Empirical Exchange Rate Models,” CEPR Discussion Paper 6598. [broken link removed] Forthcoming in Review of Financial Studies.
Fama, E.F. (1984) “Forward and Spot Exchange Rates,” Journal of Monetary Economics 14, 319-338.
Meese, R.A., and K. Rogoff (1983). “Empirical Exchange Rate Models of the Seventies: Do They Fit Out of Sample?” Journal of International Economics 14, 3-24.

Footnotes
1 More technically, the future k-period change in the exchange rate is regressed on the current k-period forward premium. If the market is efficient, the intercept of this regression should be zero, the slope (beta) in this regression should be 1, so that the forward premium today is an optimal predictor of the future exchange rate change. Also, the error term should be white noise, i.e. uncorrelated with information available today or in the past.
2 This fact is what drives much of the so-called carry trade where funds borrow in low-interest rate currencies to invest in higher-return assets in other currencies. Due to the forward premium puzzle, they can, on average, buy enough of the original currency to pay off the loan and still pocket a bundle.
3 This means a portfolio whose shares shift according to current information, especially the forward rate
 
Hey guys,

This is my first post here. After reading this and other threads on forums I must admit that I am very concerned about the euro collapsing or Ireland getting kicked out and to me, it seems wise to transfer any savings out of Ireland and into a more stable bank and currency.

On speaking with a friend of mine, a Maltese bank called Sparkasse was mentioned. I dont know why Malta or this bank but its supposed to be the 10th most stable bank in the world? Does anyone have any thoughts on why I'd need to go to a Maltese Bank and are there better options?

I was thinking of transferring most of my savings to this bank and into Canadian Dollars. I'm not an economist and would be grateful for anyones opinion on:

(a) this bank,
(b) Malta,
(c) canadian dollars
(d) whether I need purely a canadian dollar account or both a canadian dollar and euro account (if this is even possible or desirable)
(e) how to keep things above board with regard to DIRT payments etc and finally
(f) the best way to get the most out of my conversion into canadian dollars from euro e.g. convert to sterling first.

Thanks very much folks,

Newera.
 
Newera,
best advice for you is do not put all your eggs in one basket. Moving money abroad is a good move, but I don't know anything about Malata. Getting some CAD is a good move, but also look at other currencies in order to diversify.
 
Newera,

Do fiscal deficits lead to currency depreciation?
No. It is commonly believed that large fiscal deficits and high debt cause a currency to depreciate as the government borrows more from foreign sources, and investors who are concerned about inflation and default risk flee the currency. Although recent developments in the US would seem to support this relationship, there is less convincing long-term evidence that deficits affect currency rates. During the 1970s and 1980s, the dollar strengthened while the government increased deficit spending. This observation is consistent with academic studies concluding that exchange rates appear to move randomly, and there are no models to date that can reliably forecast currency returns.

You can't infer that a low debt, low inflation country like Canada will lead to a good investment from a currency perspective simply because the currency follows a random walk based on FUTURE news events which by definition are not predictable.

However, what the data clearly shows is that you are exposed to additional volatility from currency risk, and that you are rarely rewarded for this additional risk compared to an investment in short-term € money market accounts.

Investing in a Globally diversified portfolio of stocks, bonds etc across many countries does make sense. But trying to pick a foreign currency/foreign bank account because you are worried about the Euro is a bad strategy.
 
Thanks very much for the replies folks. I dont know enough about stocks and shares to invest wisely and have seen many people lose everything in stocks and shares.

My primary objective is to protect my principal savings rather than risking it further in an investment portfolio. I have nowhere to put bars of gold and dont want to increase the chances of having my home burgled.

I understand that putting all my eggs in one basket doesnt sound like a good idea, however, of all the currencies, it would appear that the Canadian Dollar has been the soundest over the past number of years. boring from an investment perspective but good for someone who wants some bit of stability in a chaotic economy.

I would incur additional charges on my account for each currency I hold .... approx €40 per annum per currency for starters, plus transaction fees. I'm just a bit boggled at the moment and feel that for every currency that I would invest in other than the Canadian Dollar, I introduce another variable and a greater chance of being burnt.
 

i put 30 k in canadian dollars back in march , one euro bought 1 . 36 canadian dollars at the time , today , the euro ( depsite all the turmoil ) will buy you 1 . 40 canadian dollars or thereabouts , obviously i chose a bad time to buy but the fact of the matter is , the canadian dollar tends to track the american dollar and the american dollar is in permanent negative territory for the past number of years , swiss franc all the way if you have currency concerns , its bomb proof
 
What is Sterling is so weak? I know the UK is in trouble fiscally but does it warrant a drop from 1.4 to 1.06? Now at 1.11 against a Euro in trouble?
 

Hi farmerette,

The difference in the exchange rate for Canadian Dollars between now and the time you bought, amounts to a nice bit of money. In relative terms its not that much of a fluctuation in exchange rates. However, if Ireland reverted back to the punt and you hadn't safeguarded your savings by converting to a currency such as the Canadian Dollar, your euros could potentially be worth between half and a fifth of their present value if you are to believe what some people are suggesting.

Newera
 
I have the same type of worries as Newera, in that my euro savings will be decimated if the euro collapses.

At the moment I have euro a/c opened in the UK, but I have yet to transfer my euros from AIB to the UK bank (Barclays in the UK).......was going to, but over the last 2 weeks the euro situation has worsened and I'm now considering converting my euros to a basket of 'stronger currencies' - probably into CAD, AUD, CHF and GBP.....my thinking on this is that if I diversified across a number of currencies, the probability of seeing my savings decrease in one currency might be offset with an increase in another currency....so the net affect would cancel out

The other options I was considering was:
1. investing into a diversified fund portfolio (something similar to what Marc outlined with Goldcore earlier in this thread)

2. paying down my mortgage outstanding with my savings.......this would thereby relieve my worries about my savings being hammered as would put them to use by reducing my mortgage. Would this be such a bad option to take??

All opinions welcomed from the AAM folk on here.....
 
swiss franc all the way if you have currency concerns , its bomb proof......

i thought the thinking was that the swiss franc was about 30% overvalued; mainly due to the large influx of money?

is it really bomb proof - even now?
 
Marc said:
This is stylised fact that is so well known that it has a name, the “forward bias puzzle,” namely high-interest currencies tend to appreciate when uncovered parity predicts depreciation.
Click to expand...
Interesting stuff. However, I would like to know exactly what statistics we are investigating here. Over the long term the following observations seem incontrovertible: Latin American currencies are both high interest and high depreciation, Swiss Francs are low interest and high appreciation, similarly the Yen. Before the Euro, the D-marc, Irish Punt, French Franc, Sterling etc. all seemed to behave as expected i.e. that generally the higher the interest rate the more long term depreciatory was the currency. So the "forward bias puzzle" does not seem to exhibit itself on long term trends.

Maybe the short term is very different. Take Euro/Sterling. For quite a while now the short interest rate on Euro has been higher than on Sterling which means at any point in this phase the markets in equilibrium must be bidding up the Euro to the point where they expect Sterling to appreciate against it, thus cancelling out the interest rate differential. Yet the opposite has happened. Of course it is impossible to make any conclusions out of this as the situation is overwhelmed by the broader EZ crisis.
 

Naturally it depends on your own personal circumstances, how much is left on your mortgage, the value of your mortgage etc but I would be slow to use my savings to pay off a chunk of my mortgage.

In the event of a doomsday scenario for the Ireland and we revert to the punt the punt would be dramatically devalued against the euro and other currencies. You would be paid in punts but since your mortgage was taken out in euros, you would probably still have to pay back the euro value of the mortgage. Your euro savings and new earnings could be worth as little as 50-20% of the euro so in effect, your mortgage will have increased by 2-5 fold meaning that you will never be able to pay it off anyway (again depending on your personal circumstances). Looking at it another way, if you had 20 years left to pay in your mortgage, it would be like having to maintain the current level of payments for 40-100 yrs which is impossible.

In my humble opinion, there would be no point in wasting your savings now on a mortgage that in the above scenario, you will never be able to pay. I would just default like the rest of the country would in that situation.
 
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