How Currencies Can Create Crisis

Reach into your wallet and pull out a dollar bill. That bill is a medium of exchange built upon trust. If one day nobody were to trust the U.S. dollar as a medium of exchange, the crisp dollar bill in your hand would be nothing but fancy toilet paper. It happened to Germany after WWI. The German government printed money so excessively to pay off the huge war debt that it led to hyperinflation. People needed a wheelbarrow full of money in order to buy a single loaf of bread. This history lesson shows that it is crucial to understand how inflation can have dire consequences on a country’s currency, especially when investing.

Since the United States has a stable currency, a number of countries like to use the U.S. dollar’s value fixed against their country’s currency. This is a method of stabilizing currency called currency pegging, where a country’s currency has a set exchange rate with a stable currency (i.e. the US dollar). In order to back up this exchange rate, the country needs to keep a reserve amount of stable currency. Once the reserve drops too low and cannot be replaced, a downward adjustment needs to be made to the exchange rate, a term referred to as devaluation.

Step back in time to 1997. East Asia had a currency crisis on their hands when Thailand’s currency, the baht, was pegged to the US dollar. Thailand had a large amount of foreign debt, causing the country to be essentially bankrupt. In addition, Thailand did not have enough US dollars in its reserve to hold up the pegged value of the baht. The baht had to be devalued by approximately 40%, which caused a recession throughout East Asia as countries close to Thailand were all affected by trade disruptions and the default of debts. Growth in East Asia that had experienced high single digits plummeted to nothing. This extreme example shows that the poor economics of a country can directly affect investors.

Additionally, the effects of changes in the relative value of the U.S. dollar can have a substantial impact on investments. A weaker U.S. dollar will benefit foreign nations importing goods from the United States. If the value of the dollar drops compared to another currency (for example, the Euro), the Euro can buy more U.S. dollars, which means foreign nations can buy more U.S. goods for less of their own currency. The opposite is true as well; when the dollar value goes up, U.S. citizens can buy foreign goods at a cheaper dollar-price.

At Fogel Capital, we are constantly monitoring indicators of large economic trends, such as long-term currency movements, in order to create actionable investment decisions. For a portfolio consultation or to learn more about our views on investing in today’s economy, call (772) 223-9686.

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