A question from a reader

As a world-famous blogger and renowned expert in the field of currency markets, I get numerous emails asking me for investment advice. I normally can't begin to answer this veritable tide of requests, but I will make the exception for this one:

Assuming the U.S. dollar is set to weaken considerably what will be the effect on the Canadian dollar. A weaker U.S. dollar will make U.S. exports more competitive and Canadian imorts less attractive to purcahse by our No.1 trading partner. Since 90 percent or so of our goods end up in gringolandia, reduced appetite for our products (and the Canadian dollars needed to buy them) will hurt the C buck. At the same time, Mr. Martin has got the country on a stable balanced budget to surplus tack that's been holding for more than 5 years now. Will that lead investors to seel U.S.dollar denominated instruments and seek the relative safety of Canadian debt, in so doing prop up the loony. Anyway, interested in what your thoughts are....Or do I pour all my money in Argentine peso and provincial quasi-currencies and scrip?

As you can see, this poor man has suffered tremendous damage due to his years working for an international news service and no longer knows how to write coherently, use punctuation, or spell the simplest words. He is also under some sort of delusion that Paul Martin is some kind of financial wizard, and that the temporary Canadian federal surplus is due to something more than drastically raised taxes and the pushing off of expenses onto other levels of government. Nonetheless, I will attempt to answer it. I like a challenge.

I first enlisted the help of an expert in deciphering garbled and unintelligible text (an 8th grade history teacher) to translate the question into something I could work with. She came up with this:

If the US dollar continues to weaken as predicted, what will be the effect on the Canadian dollar? On one hand, I think a weaker US dollar will close the trade surplus Canada has with the US, hurt the Canadian economy and drive down the Canadian dollar. But on the other hand, Canada has its federal budget under better control than the Americans, which should make Canada a better place for international investors to place their money, thus propping up the currency. So, should I put my meagre savings into Canadian or American investments? Or should I just spend it as I earn it in riotous living?

Here's my response, for what it's worth. The first force you cite as having an effect on the value of the Canadian dollar is somewhat important, the second less so. Still, I'd place my money with Canada rather than the US, but would avoid bonds.

The decline of the US buck will probably happen pretty rapidly. A couple of major players will start reducing their support (as might be happening with Buffet and the Reserve Bank of India), and then there will be a rush for the door by the rest of them. It'll be ugly, and that's because international currency markets have been rigged for such a long time. It's almost like a Ponzi scheme, the coupons only having their face value so long as they're not cashed in.

In the US, this decline will cause inflation as the prices for imported goods will rise. In Canada, sales to the US will drop, hurting our economy -- especially the services and manufacturing sectors. The resource and energy fields (with products difficult to replace domestically in the US) will do better. Our government will no doubt try to counter this trend by debasing our currency -- lowering interest rates and buying US dollars. The European and Asian central banks will be doing the same thing. It'll be as effective as shovelling back the tide.

As to the second force on the Canadian dollar you mentioned, I don't think government budgetary management has too much effect on currency prices -- though in the long run it should. Unchecked spending by a government suggests that they will be more likely in the future to inflate their way out of a deep debt pit. But right now I actually believe that the reckless lurch into deficit budget territory in the US is preventing the US buck from a crash. (Temporarily, at least.)

What it all comes down to is that the currencies of the world are on a race to the bottom. A worldwide fiat currency regime depends on the governments to actually work to preserve the value of their currencies. Unfortunately, there are too many short-term political gains to be made by letting things slide. I believe any type of bonds right now are a terrible investment, you must invest in things.

Things that people need, and which cannot be created from thin air through financial trickery are the only investments that will make it through this global convulsion. Jim Puplova has a good column on this idea. Real estate would normally be something that would fall into this catagory, but I think prices are a little excessive right now. That may not matter though if inflation really cranks up. Resource industries and physical holdings of precious metals are what I would recommend. Commodity futures are no good because it's difficult to predict when this meltdown will occur.

Now just let me step out the somewhat smug tone I've adopted in this post. I have no monopoly claim on the truth. I may not know what I'm talking about. These are just my thoughts on the subject. I have a fair amount of money invested in gold and I've done well with it, but everything isn't in that one basket. The best investment I feel is in the quality of your life in the present. A nice house you're comfortable in, good meals with friends, and a bit of travel are things you'll always have. If you also have a small stake in assets that create real and needed goods, you'll never be poor.

Posted by Bruce Gottfred at March 8, 2004 12:12 PM | TrackBack