When the Hoard Hordes

horde ( ˈhȯrd), noun

1 a : a political subdivision of central Asian nomads b : a people or tribe of nomadic life
2 : a teeming crowd or throng

hoard (ˈhȯrd), verb

1 : to lay up a hoard of
2 : to keep (as one's thoughts) to oneself

 

Mea Culpa….

 

Last week, one of our readers caught me using horde when I meant hoard.  I told him I would apologize and I hoped I could find a way to use it in the last tip of 2009.  (Yes, I'm taking a break until 8 January.)  While eating Thai food last Friday night, I came up with a title for today's tip and all I needed was something to write in the body of the tip to go with the title.  So, here goes.

 

We hear a lot about savings rates and the economy.   It can be argued that the more we save, the faster the economy will grow, as interest rates will be lower and we can invest in capital and equipment to increase productivity.  On the other hand of the economists, it is argued that if we save and not spend, the economy will be slowed – simply because people are not buying what is produced by the economy.  Lord Maynard Keynes called this the The Paradox of Thrift.

 

Below is a list of countries with their average savings rate and rate of growth in their Gross National Product (GNP) for the years indicated.  You can see that, for most countries, there is a negative correlation between the savings rate and the rate of GNP growth.  That means the following: as savings rates go up, GDP growth goes down – thus the negative.  Yet for a few countries, notably Greece, Korea, Mexico, The Netherlands, New Zealand, Poland, Spain, and Switzerland; the correlation between savings rates and GDP growth is positive.

 

Country	Years	Savings Rate	GDP Growth	Correlation
Australia	1959-2004	8.64	3.28	-0.102
Austria	1995-2003	8.53	2.14	-0.007
Belgium	1985-2003	13.3	2.23	-0.328
Canada	1970-2005	10.89	2.51	-0.128
Czech Rep	1995-2005	3.76	2.84	-0.030
Denmark	1981-2004	0.82	1.73	-0.396
Finland	1975-2005	1.96	2.62	-0.570
France	1978-2005	11.85	2.18	-0.188
Germany	1991-2005	10.77	1.49	-0.082
Greece	2000-2005	-6.17	4.16	0.744
Italy	1999-2004	10.43	1.39	-0.791
Japan	1996-2004	7.92	1.22	-0.462
Korea	1975-2005	15.28	6.8	0.176
Mexico	1993-2002	6.83	2.96	0.570
Netherlands	1995-2005	10.77	2.32	0.516
New Zealand	1986-2000	-0.91	2.1	0.064
Norway	1978-2003	3.41	2.77	-0.125
Poland	1995-2005	8.91	4.34	0.492
Portugal	2000-2002	4.03	1.84	-0.506
Spain	2000-2004	5.58	3.99	0.297
Sweden	1993-2004	7.16	2.83	-0.369
Switzerland	1990-2004	11.65	1.2	0.085
United Kingdom	1987-2005	3.27	2.5	-0.357
United States	1970-2005	4.55	3.07	-0.114
Europe	1991-2003	11.39	1.96	-0.531

 

To be honest with you, I do not know exactly what this means, although the average correlation is negative.  The negative implies that Keynes is correct and the more we save, the lower will be the rate of growth.  Of course a lot more goes on besides savings.  Innovations, exports, imports, creative discoveries, comparative advantages, wars, disasters, and other events often lead to greater or lesser economic growth, regardless of the savings rate.  (If you don't believe me, read more about the impact of the introduction of the computer to the world during the 1980s and through the 1990s.)

 

One thing I do know and I know this with certainty.  If you save, while others are spending and the economy is growing, your savings will accumulate and you'll be better off financially at the end of the period than the debtor – assuming your investment returns outpace inflation.  Thus, the mantra: Savings good, debt bad.

 

I wish everyone the best.  I've got to grade my finals and finish my shopping.  My son gets back from Michigan tomorrow and my daughter, from Pennsylvania, on Sunday.   We just had a visiting research scholar arrive from Beijing and she needs a place to call home for the year.  Simply, I've got productivity to add to our economy.

 

We are busy.  We are blessed.  Just like you.  Enjoy Your Holydays (sic).

 

-       Robert O. Weagley, Ph.D., CFP^(r)

 

Salus populi suprema lex esto. 

- Motto of the State of Missouri

 

The Final Days of the Dollar?

I read the title of today’s Financial Tip on one of those sidebar advertisments on a webpage that you are usually better off not reading.  Yet, I couldn’t resist.  The trouble is that others might have the same lack of discipline, when it comes to sidebar advertisements.  (Folks, I hate to tell you this but you probably won’t make $77 per hour with that on-line job that is being marketed.)  I then thought about what is going on with the dollar in relation to other currencies and I wanted to know more.  The result is a financial tip on exchange rate risk.  It just might be educational.

 

As a review, we all remember (don’t we?) that there are risks associated with investments and that risks include the possibilities of both losing and gaining more money than we expect at the time we make the investment.  We don’t worry much about business risk (the risk of the business doing better or worse than expected) or financial risk (the risk that over-indebted firms do better in good times and worse in bad times), as we can diversify away from these risks.  The other risks, however, are always present and we should learn to embrace them – all of them – in order to be properly diversified in our portfolio.  As a reminder, the other risks are:

 

·         Interest rate risk – the risk that security prices move in the opposite direction to that of interest rates.  If interest rates go up (down) the present value of future earnings/interest payments/dividends goes down (up).

·         Market risk – the risk that the psychology of the market causes all investments to go up or down.  (Remember how the value of stocks went down from October 2008 through March 2009?)  When people are feeling confident, their psychology causes them to place more faith (money) in the future – causing security prices to rise – or when they are uncertain, they horde their money – causing security prices to fall.

·         Reinvestment rate risk – the risk that an investment that pays a return of X% per year will have those payments reinvested at a rate either higher or lower than X%.

·         Purchasing power risk – the risk that increases (decreases) in prices will erode (increase) the purchasing power of the payments we receive.

·         Exchange rate risk – the risk that the currency in which our investment is held will either increase or decrease in value due to changes in what the currency is worth relative to the currency of the country where we live or, more importantly, where we spend our money.

Where do we stand today with respect to exchange rate risk?  The chart below indicates that, yes, the dollar has fallen relative to other currencies during 2009. Clearly, there has been a decrease in the value of the US Dollar Index, since March.  Yet, if one goes back far enough, the dollar is actually worth more against this basket of securities, than it was in late 2007.  (See the following website and change the “Periods” from 60 to, say, 1000 to observe this: Dollar Index Chart.)  Moreover, in the face of the financial crisis in Dubai and, some say, the looming financial crisis in Greece, the dollar has recently gained ground against the index currencies, as indicated by the uptick in December.  (The index broke above the 50-day moving average, typically interpreted as a bullish sign by technical analysts.)

The six currencies in the US Dollar Index (with their relative weight in the index in parantheses) are the Euro (57.6%), the Japanese Yen (13.6%), the English Pound (11.9%), the Canadian Dollar (9.1%), the Swedish Krone (4.2%), and the Swiss Franc (3.6%)  http://quotes.ino.com/chart/?s=NYBOT_DX&v=d12 .

What does this mean to you?  Let’s take a simple example and assume that you could have purchased a 100 units of the “index” (we will call the currency I$), in March, when the dollar index was at 89.  The foreign currency “index” would have cost you, in US dollars, $112.36 (= I$100 * (100/89)).  Today, when the dollar index is at 76, that foreign currency “index” could be sold for $131.58 (=I$100 * (100/76)), as the dollar is worth 14.6% less, relative to the index.  Naturally, if the dollar index would have risen against the foreign currencies, instead of falling, you would have lost money on the transaction.

Another concept that is currently being discussed is that, while the dollar is losing value against other currencies in currency markets, it is actually undervalued relative to what the dollar will buy in terms of real goods and services.  (If there is no under- or over-valuation, the market is said to be in Purchasing Power Parity.)  That is, how the dollar is trading in currency markets is different than how prices are being charged within and between trading partners for goods.  The following table shows that, for the currencies in the index, the dollar is undervalued in “purchasing power” relative to the Swiss Franc, the Japanese Yen, the Swedish Krone, the Euro, the Canadian Dollar, and the British Pound.  Or, rather, ALL OF THE CURRENCIES IN THE US DOLLAR INDEX!

http://fx.sauder.ubc.ca/PPP.html

 

“So what do I do now, in order to use this information to help me reach financial success?”, you ask. 

 

I answer, “I don’t know.”

 

I do know that changes in currency valuations are simply a transfer of wealth from countries whose currencies are devalued and toward countries where their currencies are gaining in value.  Yet, for those countries whose currencies are devalued, they should experience an increase in their relatively less expensive exports and a decrease in their imports – thus improving the balance of trade and their economic well-being, over the short run.  Moreover, an overvaluation or undervaluation of a currency based on Purchasing Power Parity will, over the long-run, be worked out and exchange rates will adjust toward parity.  If we accept this, the dollar is currently undervalued in currency markets and could be expected to increase in value, relative to the index (and foreign stocks), over the long run.

 

While I remember what the economist John Maynard Keynes said, “In the long-run, we are all dead”, I also remember what I believe about investments and the world.  For investments, diversification is a key principle and I believe that some exchange rate risk is good for a portfolio.  For the world, regardless of whether the world is getting smaller or if the world is getting flat (as described by Thomas L. Friedman in his book, The World is Flat), we will be increasingly cooperative with other nations and we will find ways to increase the economic well-being of the world.   To think we will choose otherwise, defies the lessons of history, the evolution of cultures, and accepts a long-run view where we are, as Lord Keynes said, all dead. I will not accept that vision of the future for our species.

 

Robert O. Weagley, Ph.D., CFP^(r)

Chair

Personal Financial Planning

University of Missouri 

Salus populi suprema lex esto. 

- Motto of the State of Missouri