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Tue, 06 Jul 2010 - 17:40

Hard Currencies

The term hard currency is one that is typically bandied about in countries that have had their economies devastated by the likes of war, famine, hyperinflation, or for other reasons. The stereotype is further perpetuated in films when criminals and mercenaries in these ravaged countries negotiate their terms, demanding payment in 'hard currency', typically US dollars.

Hard currencies are currencies that investors are confident won't suddenly lose their purchasing power. It is a term typically assigned to currencies from countries/economic blocs that are politically stable, highly industrialised, and conduct a large portion of global trade. It is, however, important to differentiate between currencies that will fluctuate relative to other currencies (as they are pegged) and those that have the potential to lose the vast majority of their purchasing power.

There will be volatility between all currencies that don't have a formal peg, which is completely normal. Investors must therefore be aware of the potential volatility when transacting in foreign currencies. Below is a chart displaying the rolling 12 month relative performance of various currencies versus the US dollar.

The rand is logically the most volatile currency, as South Africa's politics aren't as stable as the other countries, we aren't yet highly industrialised, and therefore don't take part in much of the global trade.

What is probably more surprising than the rand's volatility is that there are a few occasions where the 12 month movement has been in excess of 20% between hard currencies, and further still longer periods where one currency has consistently lost value relative to another hard currency. The US dollar, for instance, lost approximately 45% of its value versus the euro between 2002 and 2008.

Over this period none of the above currencies were wiped out (ala the Zimbabwe dollar) but the loss (and gain) of purchasing power between currencies over the different periods is evident. Over the long term currencies should track the relative inflation differentials between the different economies, but can deviate significantly over extended periods.

Relative to history, the volatility exhibited by currencies was extremely low during the 1990's and most of the 2000's. As different economies emerge from the financial crisis at different rates, don't be surprised to see the volatility between currencies structurally increasing again.

Take care,

Mike Browne info@seedinvestments.co.za www.seedinvestments.co.za 021 9144 966

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