Why should individuals invest in foreign currency?
What is an investment in a foreign currency? Can individuals do it?
A foreign currency investment usually looks at long term plans or expectation of a long term outcome. Unlike trading in currency or more commonly known as forex trading which is very short term or speculative in outlook, an investor making an investment in a foreign currency is also making a buy-to-hold decision.
Can individuals invest in foreign currency? The answer is a loud and clear ‘yes’ in Singapore. Due to currency controls, this option may not be available to friends from some countries.
Three important reasons to invest in foreign currency
In my opinion there are 3 main reasons to make investments in foreign currencies:
1. Long term capital appreciation
2. Interest returns
3. Diversification and protection
To understand these reasons more easily, it is perhaps easier to understand that investors really only want to invest in sexy currency.
How sexy is a foreign currency?
“A sexy currency can fetch me more of the same types of goods and services and indeed, can fetch more of my native currency over a period of time.” It enjoys long term capital appreciation.
“A sexy currency can fetch me a higher interest return than my native currency if I do not use it but keep it in a deposit.” It makes interest returns.
“A sexy currency protects my buying power better in a crisis so that I have security. It diversifies my risk and protects my financial well-being or indeed my life.” It serves as diversification and protection.
Singapore appreciates against the US Dollar – an example of long term capital appreciation
Singapore is a sexy currency compared to the US Dollar. I wrote a story about this some time back. “Besides Gold, there is one other currency that has a decade-long bull run” was its title.
Back in 2001, a US Dollar could buy 1.85 Singapore Dollars. By its low in 2011 ten years later, a US Dollar could buy only 1.2 Singapore Dollars. US Dollars could fetch less and less Singapore Dollars. It would be really un-sexy to hold US Dollars if you are a Singaporean but it would be really sexy to hold Singapore Dollars if you are a US citizen.
Lets look at this particular foreign currency investment from another angle
Based on the 2001 exchange rate of 1.85 nine years ago, it took 54 US cents for a US citizen to buy 1 Singapore Dollar (an investment in a foreign currency to him). Nine years later, this savvy investor would receive 83 US cents (his native currency) when he sold his 1 Singapore Dollar. That is an amazingly sexy long term capital appreciation of 29 cents or 54% gain.
AUD and NZD Fixed Deposits return higher interest than Singapore Dollar fixed deposit at popular retail bank – despite promotion
Won’t say anymore because the table is self explanatory. But this is an excellent example AUD and NZD are much more sexy than Singapore Dollar to hold on as deposits.
Iranians hoard US Dollars
From the Arab Times ‘Iranian ‘Gold Rush’ Amid Inflation Fears’ published on 06 February 2013.
The Iranian gold rush was mainly driven by fears about the domestic economy, particularly the risk of soaring inflation and a wobbly currency…
The reasons that people are drawn to these safe assets — gold coins and hard currency — are firstly a limited choice of investment opportunities, and secondly a fear from the weakness of the national currency,” said an economist… These are results of more potential economic instability in the country.”
This story is a very good example of diversification and protection. Because of economic and political uncertainty, Iranians thought their own currency the Rial was a lot less sexy than gold coins and US Dollars.
My Thai experience
I had the chance to visit Bangkok in Thailand during the Asian Financial Crisis in 1998. The exchange rate between the Singapore Dollar and the Thai Baht moved from a stable pre-crisis rate of around 1 Singapore Dollar to 16 Baht to crisis rate of 24 Baht. Against the Singapore Dollar, the Thai individuals experienced a loss of purchasing power by 50%. It meant also destruction of the real value of cash assets. What happened when I moved around in the city? Thai businesses I encountered asked me to make my payments in Singapore Dollar. The Singapore Dollar (an investment in a foreign currency to Thais) was a lot sexier to hold on to in a crisis.
Investing in foreign currency in the last decade
Investing in foreign currency offer gains from appreciation, interest return, protects the value of savings and purchasing power. They can be an attractive addition to a multi-asset basket and fulfil an important role of diversification.
Most commonly transacted foreign currencies such as the US Dollar, Euro, Sterling Pound, Yen and Australian dollars are also the most attractive to invest in because they are backed by the strength and size of their economy.
However the shift in balance of economic power in the last decade may mean that savvy investors want to give a good thought to what to invest in. The Chinese Yuan looks very strong whereas the US Dollar and Euro is looking a lot less sexy than before. (In another story, ‘Is the Ringgit pegged to the Renminbi?‘ there was a chart showing the Chinese Renminbi appreciating against the US Dollar). Even the Thai Baht has become a sexy currency by 2010, being hoarded by Vietnam, Myanmar, Laos and Cambodia.
Lastly financial innovation means that foreign currencies can come in different forms. Notes and coins are great for protection in a crisis because they are the most liquid. Deposits are supposed to be liquid too. However foreign currency fixed deposits in Singapore do not enjoy deposit insurance so picking the right bank is a MUST. Lastly investment in foreign currency could also be made in different forms such as unit trusts/ mutual funds or exchange traded funds. While these are based on foreign currencies, some of them are structured with derivatives which bring in a lot more risk than an individual may be able to assess.