OUTLOOK FOR CURRENCIES
Three looming, booming megatrends guaranteed
to roil the currency markets - and how to profit from them
by Robert W. Czeschin
Since
its inception, Taipan has always taken a futurist approach to identifying
business and investment opportunity. Looking forward to 1997 and beyond,
it is possible to identify three potentially world-shaking megatrends in
progress.
Taken together, they could easily take the world's most firmly
grounded financial relationships - and the investment verities that accompany
them - and stand them right on their pointy little heads.
The first of these is the headlong rush to a single European currency.
The second is rising oil prices. The third is the approaching upward shift
in Japanese interest rates.
In the chapter ahead, I will explain each of these watershed events
in terms of its effect on world currency markets. I will also tell you which
currencies to buy and sell to profit from these developments.
If, by any chance, you are among those investors who think currencies
are inherently less interesting than stocks or shares, let me say this:
The most fundamental investment decision you will ever make is not which
stock or bond or fund to buy. It's what currency (or currencies) in which
to accumulate your savings.
Choose the right one, and you get to watch your savings compound
with a vengeance. Choose the wrong one, and you risk seeing all your principal
and interest eaten up by devaluation. Ask any Russian what happened to the
value of his ruble bank after the collapse of the Soviet Union.
And if you think a ruble-style nightmare could never happen to
a reserve currency like the U.S. dollar, think again. It already has. In
terms of the 1947 U.S. dollar, today's greenback is worth only a pitiful
13 and a half cents.
There has already been a massive, slow-motion devaluation of the
American currency. And it is not over yet. If you're saving for your children
or grandchildren, the last major currency you should trust with those savings
is the U.S. dollar.
So if anyone ever tells you currencies are uninteresting or unimportant,
remember this fact: either he is totally uninformed, or his pilot light
is on dim. For successful investors, choosing the right currencies always
come first. And that's what the Taipan currency column is all about.
European Monetary Union
The basic facts of monetary union have already been agreed: Europe's
single currency will be called the Euro. The currencies of participating
countries will be locked together beginning on 1 January 1999, when the
new European Central Bank first opens for business. The currencies of member
countries will be formally merged into the Euro in 2002.
The decision on which countries will be allowed to participate
in monetary union (EMU) will be made in the first quarter of 1998, based
on the economic performance in 1997 - which is why this is such a critical
year for Europe.
To be admitted, member countries must meet certain economic standards.
Of these, the most vexing is that government deficits amount to no more
than 3% of gross domestic product (GDP). I say vexing, because it is extremely
unlikely that France and Germany - the two countries most critical to the
whole EMU scheme - will both qualify under this standard.
For France to qualify, for example, it will have to endure high
interest rates and unemployment at such high levels it could easily bring
down the government. That's one reason why former President Valery Giscard
d'Estaign urged prompt devaluation of the French franc.
As a practical matter, there are only two possible solutions to
the problem of impossible-to-meet economic requirements. Either EMU must
be postponed, or the economic requirements for membership will have to be
watered down.
If EMU is postponed, the fragile political consensus necessary
to push it through may well evaporate. If economic requirements are relaxed,
then the Euro cannot possibly be a strong currency.
Already, 60% of the German public say they will not give up their
Deutschemarks for Euros. If the Euro is perceived to be a weak currency,
this number will rise to nearly 100%. As you can see, this amounts to an
impossible dilemma for EMU.
But politicians are rarely constrained by the laws of economics
- or troubled by logical contradictions. Accordingly, the simultaneous pursuit
of mutually incompatible outcomes virtually guarantees a year of turmoil
for European currencies.
As usual, there will be winners and losers. The losers will be
the French franc and the Deutschemark. Right now, France and Germany are
following an unstated but nonetheless carefully coordinated policy of mutual
devaluation against the U.S. dollar.
Both countries hope that this will help stimulate their export
industries. The reason is that an export boom is probably their best hope
to pump up economic growth enough to meet the EMU economic requirement.
As a consequence, both currencies will be weak against the dollar
in 1997. If EMU collapses entirely, the French franc will be devalued drastically.
Beneficiaries from currency turmoil in Europe will include the
Swiss franc and the U.S. dollar, both of which Europeans regard as safe
haven currencies.
Taipan's 1997 Forecast (relative to the U.S. dollar):
French franc: bearish
Deutschemark: mildly bearish
Swiss franc: neutral
The coming boom in oil prices
Last year, oil prices climbed from under US$20 a barrel to a trading
range between approximately US$23 and US$25. This rise will continue throughout
1997 and beyond.
What's fueling this new bull market is a powerful surge in demand
- mostly from Asia. On average, China and India consume only 1 barrel of
oil per person per year. But the economies of both countries are growing
rapidly. China, for example, has averaged double-digit growth for nearly
a dozen years.
China also ranks among the world's six top oil-producing nations.
But it already uses up all the oil it can produce, and more. In 1995, it
became dependent on imported supplies to meet its energy needs.
How much oil will China and India need to create an Asian tiger
economy standard of living? Well, Taiwan consumes 11 barrels per person
per year.
Let's be conservative and assume that China and India get only
one third of the way to Taiwanese levels of development in the next few
years. This alone amounts to an increase in world consumption greater than
Saudi Arabia's maximum output.
Of course, there is only one Saudi Arabia. To accommodate that
much additional consumption, prices will have to rise sharply.
The major beneficiary of rising oil price will be so-called petro-
and natural-resource currencies such as the Indonesian rupiah; the Australian,
New Zealand, and Canadian dollars; and especially, the British pound.
Because Britain will remain outside European monetary union, the
pound will also benefit from safe haven buying. (See previous section on
this topic.)
Taipan's 1997 Forecast (relative to the U.S. dollar):
Indonesian rupiah: mildly bullish
Australian dollar: mildly bullish
New Zealand dollar: mildly bullish
Canadian dollar: mildly bullish
Pound sterling: bullish
Looming reversal of Japan's prevailing low-interest
policy
Rising oil prices would normally be bearish for Japan, because
it depends on imports for 100% of its oil needs. But in this case, the bearish
effect of rising oil prices on the yen will be more than offset by other
factors.
The yen's year-and-a-half slide from ¥80/US$ to ¥113/US$
has already tripled the profits of major exporters such as Japanese automakers.
In the last half of 1996, these profits came increasingly at the expense
of American car companies. As a consequence, another Japanese-American trade
crisis will surely erupt unless the Japanese take steps to support their
currency.
The most likely step will be an increase in Japanese interest rates
- which are now at an historic low of 0.5%. In 1997, both interest rates
and the yen will be higher than they are today.
Because Singapore normally manages its currency to steer a middle
course between the yen and the U.S. dollar, a good year for the Japanese
currency also suggests a good year for the Singapore dollar. (Having doubled
against the US$ since 1987, the Singapore dollar has a superb long-term
track record for dollar-bloc investors.)
Taipan's 1997 Forecast (relative to the U.S. dollar):
Japanese yen: mildly bullish
Singapore dollar: mildly bullish
What currencies will be good for savings in 1997?
The precise, up-to-the-moment answer to this question is Taipan's
Multi-currency Cash portfolio - which I will review and update throughout
the year in the monthly Taipan currency column. For 1997, my initial recommended
mix of currencies is: 20% U.S. dollars, 30% Singapore dollars, 10% New Zealand
dollars, 20% sterling, 20% yen.