• James Twidale

CURRENCY WAR


Our Rand is often spoken about in a very satirical fashion. There are jokes that go on about how weak the Rand is. For most South Africans the Rand is a good proxy for the “Wealth Effect.” I think the proxy is a good one.

The “Wealth Effect” is when consumers or corporates spend more when they feel wealthier. The feeling of wealth is an interesting concept. For example when property values in general increase, most home owners feel wealthier because they assume they can sell their property at a higher value and increase their total wealth, even if they have no intention of doing any such thing. The increased false confidence pushes people to spend as if they were in fact wealthier.

The Rand has the same impact. When the Rand is weak we all tend to feel far worse-off. If we look at the period of recent weakness it is not hard to see why this is the case. In sync with the most recent Rand weakness, we have seen economic growth grind to a halt and inflation has increased well-above the SARB target band. The fact that inflation has risen so dramatically has not only increased the cost of most items that we consume, but also reduces our ability to save. The result of higher inflation has also led to a series of interest rate hikes, putting more pressure on the already strained pockets of most. It is not hard to see why we all have felt a little poorer of late.

The Rand is therefore a great guide for how South Africans feel about their general wealth. When people feel poorer they tend to make sub-optimal decisions. These sub-optimal decisions are also typically made when people are too optimistic about their wealth, buying cars they probably can’t afford for example.

The decision local investors tend to make is to abandon all reason and purchase offshore assets without much consideration. The logic seems fairly undeniable. If the Rand weakens, local investors are becoming poorer in a global context .These investors could then buy offshore assets which will not continue to plummet in value like their current wealth. All seems well and logical.

History has taught us many times that making our investment decisions based on this alone is a foolish one. Currency is an asset class that can render many investment decisions poor ones. An investor, buying any offshore assets at the same time that all investors want to buy the same assets, is unlikely to pay a reasonable price for that asset. The same way that when everyone is trying to sell something and no one wants to buy it from them the price very quickly plummets.

If you are buying non-Rand assets the decision should be based on merit and reason. Merit refers to purchasing assets that are fairly valued or undervalued either on an absolute or relative basis. Reason in the portfolio context should mean for diversification purposes which reduce total portfolio concentration and risk. Any other reason is likely to end in you experiencing the opposite of the “wealth effect” in time.

Currency is often considered a great release valve. When the world happened to be very pessimistic about South Africa , emerging markets and commodity producers, the Rand depreciated noticeably. When the world realised that commodities were not as unwanted as previously considered, the Rand strengthened.

The US Federal Reserve subsequently had to revise its interest rate hiking cycle on more than one occasion and again the Rand benefitted. South Africa avoided the dreaded ratings downgrades in June and yet again the Rand strengthened.

I could probably add a slew of other factors that have moved the Rand in both directions of late. Investors who purchased the right offshore assets at the right valuations for the correct diversification reasons are likely to be unfazed by the recent gyrations in the currency. Many however would feel foolish for succumbing to their behavioural instincts.

We are not in the business of predicting the value of the Rand over short periods. The reality is that the vast majority of what has been moving the local currency of late has very little to do with what is happening locally.

We are in the midst of a global currency war. This war is being waged by the monetary superpowers of today, global central banks. All of which are fighting to remain competitive. I would probably be safe to argue that the Rand will remain at the mercy of global central banks and global policy decisions for the foreseeable future. This volatility of most currencies remains elevated as this war wages on.

Investors are likely to swing between the mass euphoria and apocalyptic pessimism caused by fluctuations of the Rand in the near future. The “wealth effect” or “negative wealth effect” will play its part in this. The only way to remain sane in this war of no bullets is to make sure that the merits and reasons for all investment decisions are sound. If you want to invest offshore or increase offshore exposure via local assets, do so for diversification purposes with a long term time-frame in mind. If not, there is a chance you have fallen victim to the war over which you have no control. The global currency war is causing investors to fight a war that they are ill-equipped to fight. It is difficult to avoid feeling poorer or wealthier when your assets are deemed larger or smaller. We fool ourselves into a false sense of confidence around inflated numbers and pessimism around deflated numbers.

One way to avoid this trap is to ensure that you make this investing decision in a rationale and objective fashion. An investment professional or financial advisor may very well assist in making sure the decision is made in sustainable fashion.

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