traded securities markets. I exclude the yen for several reasons.
Uniquely, Japan already has a long history of deflation, and it
“managed” its currency with very low interest rates long before
it became the norm. As a consequence, the yen has experienced
the enormous unwinding of its carry trade. (In other words,
it was kept artificially cheap until other central banks slashed
interest rates.) In contrast, the pound has proven a good proxy
for all the other currencies belonging to recently dynamic but
debt-heavy countries and a tolerable proxy for those with less
debt—India, South Korea, Australia, Mexico, Brazil and Russia,
to name the more important ones.
Now consider a portfolio invested 50 percent in the American S&P 500 and 50 percent in cash. If we measured the value
of this portfolio in the chosen currency basket, how would it
have fared between the time of the stock market’s peak value
in October 2007 and the end of 2008? If we choose my simple
basket, it may be a surprise to some that the portfolio’s market
value fell a little less than 10 percent. But it may be more surprising that the end-of-year value was some 4 percent greater
than it was on July 15, 2008, over two months before the stock
market started its headlong decline. On the other hand, despite
the stock market’s revival between its low of mid-March and
the end of May, the portfolio’s value has been virtually treading
water over that period.
If we use the Federal Reserve’s major currency dollar index,
our loss was somewhat greater. In this case, I chose simply to
take the index itself without any dollar weighting, because the
dominance of the yuan provides plenty by itself. The yen becomes significant and the euro and pound much less so. But
even here, we experienced almost our entire 2008 loss by July.
And mid-March through May saw no net improvement.
Deleveraging Equity investment
With Permanent Cash
American investors were somewhat worried in July 2008, but
the greatest fear at the time was inflation, driven by oil and
food prices. Six months later, with non-negative returns on our
“global currency” portfolios and consumer prices tumbling with
no end in sight, shouldn’t U.S. investors have been celebrating?
At year’s end, the funds were projected to buy far more goods
and services than was thought possible in the summer. Given
the downbeat media commentary at that time, was it such a
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