The Sliding Dollar

On today’s show we’re talking about foreign exchange. The question is what does foreign exchange tell us about our investments and our point of reference?

You might be sitting in your living room as you listen to this podcast. You think you’re standing still, but in truth the earth is spinning at 1,037 miles per hour at the equator, or roughly 70% of that at the 45th parallel. You’re really travelling quite fast. But wait, the earth is spinning around the sun at a speed of 67,000 miles per hour. You’re not standing still at all. You’re in supersonic flight and you don’t even know it. You get the idea.

When talk of money, we tend to use our own currency as the point of reference. Maybe you use the US dollar as the point of reference. Maybe your point of reference is ounces of gold, or perhaps bitcoin. So when the dollar drops in value against the Euro, or the Japanese Yen, you might not notice

This week Mark Haefele, Chief Investment Officer at UBS in Zurich said that they’re advising some of their clients to diversify their holdings into Russian Rubles and Indian Rupees. That’s because they’re expecting the US dollar to lose value over the next year against a basket of foreign currencies.

Currency markets have traditionally been driven by the most attractive currency. But lately, rather than being attracted to the best currency, traders increasingly a being attracted to the least worst currency. None of them are great. Interest rates in India are much higher than in Europe of the US. Money deposited in an Indian bank will get you somewhere between 4-7%. Mortgage rates are between 8.5%-9%. The Russian central bank has kept interest rates at 4.25% in their latest guidance. The Indian Central bank has set its rate at 4%. So investors in search of yield are placing a bet that neither Russia nor India will default on their debt within the term of the bonds maturity.

You know something’s wrong when India and Russia are being put forward as alternatives to the US dollar. So why would UBS be recommending this?

Let’s look at the practice of the US issuing government debt for most of my adult lifetime. The Fed would print some cash. The Treasury would issue Treasury bills and sell them on the open market and investors domestically and around the world would buy these up. The largest buyers for these T-Bills have traditionally been the Japanese central bank and the Chinese central bank. Together, Japan and China own about 10% of the US debt. Foreign governments own approximately 30% of the US debt. But since the start of the pandemic, there has been an unprecedented printing of money.

Just last week, Joe Biden put forward another 1.9T in proposed pandemic relief spending. For now, all of this newly minted debt is going to be held on the balance sheet of the Federal Reserve. The US issued nearly 5T of new money in the past year. It’s hard to wrap your mind around these numbers.

A lower dollar makes the cost of imports go up. The US imports a lot of products from overseas and continues to have a balance of trade deficit with its major trading partners including China.

The price of oil will go up. Since oil and many commodities are denominated in USD, we can expect energy costs to go up in response to the drop in the dollar.

So what does it mean for real estate investors when the dollar falls in value?

It means that the cost of imports go up. It means that we enter a period of higher inflation. It means that the cost of construction goes up, which ultimately affects the affordability of new housing. That in turn affects the cost that new buildings must charge for rent. That too can be inflationary.

As we’ve talked about recently on the show, when inflation is the new game, the rules have changed and you need to align your portfolio and your investment strategy accordingly.