Inflation hedge? Buying foreign currency

[Captain Cactus]

Thoughts on keeping a small percentage of net worth in a stable foreign currency as an inflation hedge?  For example Swiss Francs?  Heard the idea on a recent Radical Personal Finance podcast (not the focus of the whole episode, just a part of a call in show).

[waltworks]

Low rate mortgage, TIPS, i-Bonds, gold if you're a gold person. I wouldn't personally consider any currency inflation proof enough to justify holding it for that purpose.

-W

[NorCal]

Thoughts on keeping a small percentage of net worth in a stable foreign currency as an inflation hedge?  For example Swiss Francs?  Heard the idea on a recent Radical Personal Finance podcast (not the focus of the whole episode, just a part of a call in show).

Honestly, this sounds dumb for a variety of reasons. You’re not actually eliminating inflation risk. Hypothetically, what if CHF inflation is higher than USD inflation?  Are you protected from inflation, or are you actually just trying to play currency trading games?  And while expected inflation is factored into currency values, it is only one of many parts of the overall value. Even if you’re right about the inflation hypothesis, the trade could move the opposite direction from how you bet.

There are way better ways to protect yourself from inflation than play with FX markets.

[maizefolk]

In principle this works. In practice it's a lot harder once you try to figure what what currency to buy.

Swiss francs. It's a relatively small market and highly in demand. That means that right now if you want to hold swiss francs in a bank, you'll pay close to 1% a year in negative interest back to the bank. To me that seems like a steep price to pay.

Euro? Still worried about stability+fiscal policy.
Yen? They're trying really hard to GET some inflation.
RMB? Hard if not impossible to hold outside of China.
Real? Already losing purchasing power to higher than the US inflation. (The Ruble has the same issue)
Australian Dollar? Value is vulnerable to movements in commodity markets.

And so on.

[PDXTabs]

And so on.

Yup. I believe that three year Ukrainian government bonds are currently yielding 15.98%. If Russia backs down that will have been a good bet.

[Captain Cactus]

All good perspectives, thank you!

I was thinking about trading over a little US cash for some Swiss francs… maybe $1500-$3000 worth.  I guess that wouldn’t get me far.  But it could be a compliment to ibonds, gold coins, US dollars, etc…

[maizefolk]

Yup. I believe that three year Ukrainian government bonds are currently yielding 15.98%. If Russia backs down that will have been a good bet.

Huh. I figure if Russia goes for a full invasion and occupies Kiev the bonds will go to zero. So if they're only trading at 16% annual interest that's a reasonably good sign the market thinks Ukraine is more likely to still exist three years from now than not. I find that surprisingly reassuring, thanks!

[Captain Cactus]

Yup. I believe that three year Ukrainian government bonds are currently yielding 15.98%. If Russia backs down that will have been a good bet.

Huh. I figure if Russia goes for a full invasion and occupies Kiev the bonds will go to zero. So if they're only trading at 16% annual interest that's a reasonably good sign the market thinks Ukraine is more likely to still exist three years from now than not. I find that surprisingly reassuring, thanks!

I sure hope that is the case...the last thing the world needs is another war.  Such sadness. 

[ChpBstrd]

Yup. I believe that three year Ukrainian government bonds are currently yielding 15.98%. If Russia backs down that will have been a good bet.

Huh. I figure if Russia goes for a full invasion and occupies Kiev the bonds will go to zero. So if they're only trading at 16% annual interest that's a reasonably good sign the market thinks Ukraine is more likely to still exist three years from now than not. I find that surprisingly reassuring, thanks!

I remember about 7-8 years ago when Greek bonds were yielding about 15% and I thought people were nuts chasing those yields. Those bonds paid off, but I think there were a lot of equities at a similar level of risk but which ended up with better returns.

Biden and the EU may have rallied enough unity to dissuade Putin from taking all of Ukraine. His de-facto annexation of East Ukraine could be a face-saving finishing move that sets up an East Germany / West Germany status for the next couple of decades.

Regarding the OP's question, that would just be a move trading inflation risk for forex risk. I don't see a net gain there.

[RobertFromTX]

The Swiss franc had a very gold-like "safe asset" aura in the 2008 GFC. And overlap CHF/USD with Gold you see they peak around the same time 2011. There was really nothing special about the franc other than a prevailing search for anything safe. What we know now with hindsight is that equities were the safe asset beginning in 2009, but many reasonable people were so shell shocked they were still looking for safe assets well in to 2011.

https://www.google.com/finance/quote/CHF-USD?window=MAX&comparison=NYSEARCA%3AIAU

[vand]

I'd view that as currency diversification rather than an inflation hedge.  I think its a good idea to be globally diversified, but make sure you're doing it for the right reasons.

It's funny how people will always overlook the obvious. If you want to hedge against currency dilution then the easy and most obvious play that has always worked in the past and appears to be working again a treat right now is is to store your wealth in things that cannot easily be diluted - hard assets.

[SeattleCPA]

Thoughts on keeping a small percentage of net worth in a stable foreign currency as an inflation hedge?  For example Swiss Francs?  Heard the idea on a recent Radical Personal Finance podcast (not the focus of the whole episode, just a part of a call in show).

Wouldn't an allocation to real assets be the cleanest way to add some inflation protection?

If you've read or heard of David Swensen's asset allocation formula, you might already know this... But his rationale for including an allocation to TIPS and an allocation to REITs was to hedge against inflation.

P.S. Can't recommend enough reading Swensen's "Unconventional Success" book.

[Captain Cactus]

I'd view that as currency diversification rather than an inflation hedge.  I think its a good idea to be globally diversified, but make sure you're doing it for the right reasons.

It's funny how people will always overlook the obvious. If you want to hedge against currency dilution then the easy and most obvious play that has always worked in the past and appears to be working again a treat right now is is to store your wealth in things that cannot easily be diluted - hard assets.

Yes, maybe currency diversification is the way to look at it vs inflation hedge.  I wonder, can a US American have a bank account with an international bank and simultaneously hold 2+ separate currencies?  For example $5,000 US dollars and 3,500 CH francs?

When you say hard assets, the things that come to mind are gold and real estate.  What other types of hard assets are practical for the average person to buy/hold?

[ChpBstrd]

It's funny how people will always overlook the obvious. If you want to hedge against currency dilution then the easy and most obvious play that has always worked in the past and appears to be working again a treat right now is is to store your wealth in things that cannot easily be diluted - hard assets.

Just like the USD-to-Swiss Franc trade is an exchange of US inflation risk for forex risk, going from USD to "hard assets" is a tradeoff of US inflation risk to market risk in real estate, precious metals, or commodities.

"Hard assets" might shield a person from inflation, but they can also suddenly drop 30-40%. So someone who trades all their idle cash for hard assets is not avoiding risk on net, they are trading one type of risk for another. In a sense, any investment decision is a choice about which risks to be exposed to. The herd of investors getting cues from the financial media or their own narrative stories can sometimes swing their risk exposure far in one direction or another. Boom and bust then occurs on both the individual and market-wide levels as large numbers of people decide together that there is no risk whatsoever in a particular bet.

I can imagine such cycles because I've seen them. E.g. Inflation starts rising. Investors flock to "hard assets". The Fed raises rates. Hard assets rise as recession sets in, and people start making them a permanent majority of portfolios. Then suddenly the hard assets suck compared to stock returns again. The internet was FULL of oil enthusiasts in 2007, real estate geniuses in 2005-2008, goldbugs in 2013, etc. Many of them looked at their past performances and decided they had found The Way to reduce portfolio risk. Then the bottom fell out and the whole herd was panic selling. Late arrivals were especially likely to have bought high and sold low.

The re-balancers did OK, but the people running away from one particular risk after another got slaughtered like a teenager running through the woods in a horror movie.

[RobertFromTX]

The herd of investors getting cues from the financial media or their own narrative stories can sometimes swing their risk exposure far in one direction or another. Boom and bust then occurs on both the individual and market-wide levels as large numbers of people decide together that there is no risk whatsoever in a particular bet.

I can imagine such cycles because I've seen them. E.g. Inflation starts rising. Investors flock to "hard assets". The Fed raises rates. Hard assets rise as recession sets in, and people start making them a permanent majority of portfolios. Then suddenly the hard assets suck compared to stock returns again. The internet was FULL of oil enthusiasts in 2007, real estate geniuses in 2005-2008, goldbugs in 2013, etc. Many of them looked at their past performances and decided they had found The Way to reduce portfolio risk. Then the bottom fell out and the whole herd was panic selling. Late arrivals were especially likely to have bought high and sold low.

The re-balancers did OK, but the people running away from one particular risk after another got slaughtered like a teenager running through the woods in a horror movie.

I'm very much fighting this inner demon with allocating new dollars. Just sticking to my AA plan which means a lot of my dollars are going to equities and long term treasuries (since both are down). I have to remind myself that the gold etf's I purchased in 2020-2021 are doing their job today and the equities and treasuries I buy today will doing their job in years to come.

[maizefolk]

I wonder, can a US American have a bank account with an international bank and simultaneously hold 2+ separate currencies?  For example $5,000 US dollars and 3,500 CH francs?

It's possible to get an international bank account but a lot of banks would really prefer NOT to have US customers. We're messy for them with FACTA rules.

Also remember you need to declare your accounts if you're over $10k in assets abroad. And do it EVERY YEAR. The penalties are quite steep even for non-willful failure to comply.

[MustacheAndaHalf]

I've avoided the foreign exchange markets, but you can buy currency futures there.  That would also allow you to keep the investment in the US, and avoid dealing with FATCA rules on foreign assets.

[NorCal]

I've avoided the foreign exchange markets, but you can buy currency futures there.  That would also allow you to keep the investment in the US, and avoid dealing with FATCA rules on foreign assets.

As a general rule, it's best to avoid investments where you can lose more than 100% of your invested capital.  All it takes is one really bad day to turn a reasonable portfolio into complete insolvency.  And if you invest long enough, you'll have that really bad day sometime.

[NorCal]

On a positive note, your USD portfolio is currently acting as a great hedge against inflation in the ruble.

[MustacheAndaHalf]

I've avoided the foreign exchange markets, but you can buy currency futures there.  That would also allow you to keep the investment in the US, and avoid dealing with FATCA rules on foreign assets.

As a general rule, it's best to avoid investments where you can lose more than 100% of your invested capital.  All it takes is one really bad day to turn a reasonable portfolio into complete insolvency.  And if you invest long enough, you'll have that really bad day sometime.

I agree with that general rule, but "invested capital" and "inflation hedge" are different scenarios, with inflation hedge being far more common.  Many international businesses have purchases or sales in foreign currencies, and they use the currency futures market to lock in the prices for those costs or revenue.  Companies look at the amount of currency controlled, rather than the much smaller amount they spend to buy the currency futures contract.

For someone just speculating or not planning to convert actual currency, maybe "currency options" make sense - but again, I've never dealt with them.  Much like stock options, you have the ability to profit off the investment, but are not required to take action.  You can lose at most 100% of your investment, unlike with currency futures with immense levels of leverage.