Friday, April 20, 2007

I consider Another Investment "Detour" (as a sort of defensive speculation)


Last month I read this article (as well as this article) that drove me to thinking. The article was written in March 2007, and it describes a changing situation over in China.

As I type this China is sitting on an incredibly large cash reserve that has been built up from their massive imbalance. They have been holding about 70% of this cash reserve in US Dollars, which probably means they own US government bonds and investment instruments.

The article describes China having $1.07 trillion in these reserves, that is growing at a rate of $20 billion a month! (That means they currently hold about $750 Billion in US dollars)

The article goes on to say that it is not clear what the new agency in control of this money has for an exact mission, but it is most likely to build internal infrastructure within the country, for both social and industrial gain. What that exactly means, no one is sure.

But one thing that seemed clear, the Chinese will now be diverting at least a portion of this money....apparently beginning with $200 billion. The article speculated that the new agency would probably continue to apply pressure to the remaining reserves held in currencies, with the result being that there might be a pressure to get higher yields....they talk about in the range of 6%.

If I'm not mistaken, current US Bond investment yields are in the 4-5% range, so this would result in a pressure to increase that....but what does that mean? Could it mean inflation? Would the government start the presses to supply that yield? Would the US dollar continue to slide in value on the world stage?

The Chinese have apparently uncoupled the Yuan value from the dollar, so the two currencies are perhaps only tied together by this large holding of US Dollars in China. Will they move even further apart? Will the dollar lose the "shine" it has as the world's stable currency....to the point where other countries to divest in their holdings too? Many people are holding dollars because they are "as good as gold"......will the Euro take over that mantle?

WHAT TO DO:
All of this information is great, but what is a person to do with it? That was my question.

Being the person who likes diversification, my first thought was to find some other currency and invest in it.....maybe buy some of it. In fact, perhaps buy a bit of 2 or three currencies. But which two or three?

Given the article above, the obvious (and in my opinion wrong) target was the Chinese Yuan...or perhaps the Indian Rupee. But I think those are wrong because if the theory that the US will be hurt by falling dollar value, then countries that are currently relying on the US market will also be affected when the downturn happens. Yes, it is true that China and India will be holding the best hand in that card game of chicken....having all the production capacity to produce for the "next" economy that steps up to take the #1 position once the US drops to #2 or #3.....but that is after they take a small bath when the US slides from grace.

I needed to look to a country and currency that was not as connected to the USA, China or India.

I'm still looking, but I'm thinking of the Swiss Franc, and to some extent the Euro. (if the middle east were not such a powder keg, I would consider there too because they hold a natural resource that will always be in demand until it is pumped dry, so they hold a natural strength in both times of good and bad.....but the currency and investment in it or any country is only as strong as the government holding it up.)

MY IDEA: (undecided)
I thought I would perhaps take my investment and buy government and commercial bonds that are sold in the currency I am interested in. That is, these investments can NOT be priced or sold in Dollars since it is the dollar that I am hedging against. They can't be bought on the US Stock or Bond market....probably in another market, and in another currency. But how and what?

I still have not thought it all through....but my money I am considering is currently in a 15 month CD getting somewhere in the mid 5's for interest....so I have about 13 months to figure this out.

MY FINANCIAL ADVISOR'S SUGGESTION:
I went to see him yesterday for our regular quarterly review and things were going along just fine. (maybe some day I will release a description of my investments, but I'm not quite ready for that right now)

I posed this question to him, and he instantly sprang forward with information on two funds...one a bond fund and the other a mixed equity/bond fund....with the latter being a very high tech activly managed fund by some sort of MIT Business-Science PHd type....driven by three modern economic models of the world economy.

Well, all of that sounded nice, and I have not yet digested the suggestion, but it somehow did not fit the model of what I thought needed to be done....it doesn't seem to address the basic defense I was trying to implement, though it might since the fund was trading in foreign currency.....but being a fund, and one sold in the USA to US investors, a portion of it's "price" will be derived from the supply and demand of the investors......and if it is the slow slide of the US I am defending against, I don't think I want US investors as part of the "mix" that drives the value of this investment in particular.

SLOW VS FAST SLIDE:
I guess the heart of this whole discussion comes from my concern that the US is a huge debtor nation, and that we will eventually pay for it with lower dollar values. This I believe, but the question is how will it come about.

First there is a question of how....by inflation or deflation? I was initially in the camp of deflation, but I can see that the world hates deflation so much that it will do whatever it can to stay away from that cliff.

So it appears that if you were a betting man, that Inflation would be the bet. (My friend Pradeep has always been in this camp...and I guess his arguments have won me over....but they are too long to write here now)

Now, the next question.....how fast.

Pradeep believes it will be swift. He essentially believes there is a mania around US Dollars that the world will quickly lose once it begins to slide. He believes the slide will be swift....on the order of weeks. He believes this because once the slide starts, people will see their currency reserves value falling and will understand that the last one out is the worst loser. (just look at the fall of the stock market and tell me that wasn't the truth. I have a story about Sun Stock I could write about....)

I tend to think that it will be a slow slide because no one wants to see their currency investments disappear, so the move out of dollars will be slow and careful. It will be like the story of the frog in the pan of slowly heated water. The frog has such a poor set of senses for feeling heat that such slow rising water temperature is not even detected and after a while it doesn't even know it is dying in a pot of boiling water.

MORE INVESTIGATION:
As I noted...I have about 3 months to decide since my money is now in a CD. More on this in the future....my analysis is not complete.

Please post your thoughts and ideas....tell me where I am all wet and give me your opinions. (I want to learn)

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