Why Your Portfolio Needs Diversification Into Foreign Currencies

Written by: Chuck Butler   •   Posted under: Finances

Why Your Portfolio Needs Diversification Into Foreign Currencies

To protect your portfolio from today’s “falling dollar,” you should diversify into assets like foreign currencies and precious metals. Here’s why this makes sense.


The dollar’s strength is linked to the size of the U.S. deficit. Since 1971, when the dollar was removed from the gold standard and allowed to float, we’ve seen it fall and then rise again four times. And each time, you can draw a direct correlation to the size of the federal deficit. Growing deficit, weaker dollar. Narrowing deficit, stronger dollar.


That’s why it’s important to look at our current deficit position. It will give you a strong indication of the dollar’s direction.


Today, the U.S. budget deficits, which used to be considered “unsustainable” at $400 billion a year, have jumped to what most likely will be near $2 trillion this year. The Congressional Budget Office (CBO) has issued a report saying it believes the U.S. will mount an additional $9 trillion in budget deficits for the next nine years. Budget deficits go straight to our National Debt, which now stands at $11 trillion and will be at $20 trillion in nine years if the CBO is correct. (Keep in mind that most of the time these forecasts are understated.)


Over time, the Treasuries that we issue and sell to foreigners to finance our deficit will need to be paid off. This is just like having a loan from the bank. The foreigners loaned us money, we gave them collateral. But sooner or later, the loans will come due and need to be repaid—with interest. Some forecasts predict that by 2017, the U.S. will not have enough tax receipts to pay for the interest on the Treasuries, much less the loans in full.


So what’s a country to do? Well…it can allow a general debasement or weakening of its currency over time, so that when the loans come due, they can be paid back with cheaper dollars. But this weakening of the dollar devalues your assets, too.  So to protect yourself from this eventual debasement of the dollar, look today to foreign currencies. Like precious metals, foreign currencies are an excellent asset to use as a diversification tool because they have a low correlation to other investments in your portfolio and different pricing mechanisms than other investments.


Given the historic run-up of the U.S. deficit, you would think the dollar would be falling like a rock. In fact, it has already dropped about 10% this year (since March). But that’s not the “general debasement” I’m talking about. It’s likely to get much worse. That’s why I recommend you diversify a portion of your dollar-denominated portfolio now.


Which currencies should you buy? I use the old saying that a currency is the stock of a country. If you’re familiar with valuing stocks, you can use those same skills to choose currencies.


First, consider countries that have “something to sell to other countries.” Today, those include: Australia, New Zealand, Brazil, South Africa, Norway, Canada, and Eurozone.


Also, countries with surpluses are always at the top of my “hit parade” of currencies to consider. Today, that means: Canada, Eurozone, Norway, Sweden, Switzerland, China, Japan, Hong Kong, and Singapore.


In addition, countries taking steps to narrow their deficits get honorable mention. Today, that means Australia and Brazil.  Using these criteria, then, look for the countries that score strongly in all three categories. There’s your list of currencies you should buy. And do it before it’s too late.


November 2009, Written by Chuck Butler for International Living Magazine (www.internationalliving.com)



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