How to Protect Yourself From a Currency War

currency-protectionWhether it cause a reduction to our personal net worth, a lower salary, or an increased overall cost of living, competitive currency devaluations can have an impact on our daily lives. The trick is to then make sure that we can protect our personal nest eggs from these risks that are beyond our control. We can do this by understanding the fundamental implications of a currency war, and how it is that we can keep our savings in asset classes that protect against the risks of someone else’s inflation.

The first step to protecting our personal savings from competitive currency devaluation is to look at the rates at which other countries are depreciating their currencies. This information will be published by foreign governments, and will then be priced at either a discount or premium to this rate of depreciation as a result of the currency market’s sentiment about whether or not the policy will be escalated in the future. By looking at the country’s posted currency price target, and some long-term futures contracts that banks are pricing in for the likely prices of these currencies in the future, we can start to understand what the competitive landscape for currencies looks like. Specifically, we can see the magnitude of the volatility will look like in the future.

For example, Japan has recently taken steps that have effectively presented as much as a 17% devaluation of its currency, in the interests of supporting its exporting businesses. Such a step is an extremely aggressive maneuver, and has some very serious implications for us here at home. Firstly, Japan competes with the USA as a car manufacturer, and is effectively putting its entire international inventory on sale through its currency. This means that people working in the auto industry might start to feel the financial pressure as their yearly bonuses fall short as a result of reduced sales volume. Alternatively, someone looking to sell an older car might notice that the price of new vehicles has reduced by as much as 17%, and therefore requires that they reduce the sale price of their older car by just as much to meet the competition.

Upon determining the magnitude of the volatility that is going to be present in the markets, we can start to look at how it is that we can remain a step ahead of the currency war to continue meeting our financial goals. This can be done by breaking our assets down into physical and currency assets. Physical assets will be those assets such as house and cars that have material value in usage and as collateral value to a bank. Currency assets are then those assets which have liquid value, or can be used in financial markets, such as investments or savings accounts. From there, we can look at how each of these maintains its value with respect to the local and international markets.

For example, a domestic bond might gain in value as investors flock from countries that are depreciating the value of their currencies. Alternatively, as discussed above, the value of a car to the domestic market might decrease in terms of resale value as international competitors discount their prices dramatically. However, just because the market value of a physical asset has been impaired, doesn’t mean that its collateral value has been reduced. Since the used car is still worth a fair price in terms of its physical price, even if consumers are not necessarily willing to pay that price right now, a saver can take advantage of a bank’s credit facilities to unlock the value in that vehicle.

For example, if car prices drop by 17% because of an aggressive Japanese monetary policy, a borrower can instead borrow against the car at a rate of 5-10%, and use those funds to buy the new vehicle, rather than take the 17% result because of a lower sale price. However, if we are located in a country that is in the midst of an aggressive expansionary policy, we would be better off selling the vehicle instead of borrowing against it, because of the way in which the interest rates of the loan would likely be higher to make up for the depreciating currency.

In the end, what we need to do to protect our savings from a currency war is to understand the difference between the tangible value of our assets and their currency value. From there, we can strike a balance between the value of our assets as sell-able goods, or as tangible goods.

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