Money: Cashing in on Currencies

The proverbial blood is running in the streets of the currency markets, making a number of basically sound foreign monies attractive buys. It is doubtful that Bernard Baruch, who coined that phraseology, was a currency speculator, but he would probably find some of today's bargain-basement currency rates irresistible.

For instance, at this writing, the Swiss franc is selling for 48 cents—20 cents below its all-time high of autumn 1978, nearly a 29 percent depreciation. The German mark, at a current price of 43.8 cents, stands nearly 14.5 cents below its October 1978 high, a 25 percent depreciation. The French franc, jolted by the leftward lurch of the last election, stands at a 10-year low. At the current rate of barely over 18 cents, the franc is off 28 percent from its all-time high of 25 cents.

Depressed as these exchange rates may seem, the way the dollar has been going, the foreign exchange markets could become bloodier yet. The mark and the two francs, as well as other currencies, could fall even further against the ultrabullish US dollar.

The primary reason for the strength of the dollar and the weakness of the traditional "hard currencies" is high US interest rates. Once again nearing record nominal levels, rates on US money market instruments are also achieving a very high real level in terms of diminishing inflation. For now, US inflation is back in single digits. The economy appears strong, with GNP and productivity growing and the trade deficit narrowing.

Even if the impressive US performance continues, however, there is little doubt that the dollar is now as overvalued as it was undervalued in 1978. As the economy moves out of the recession and credit demand increases, inflation is sure to creep back into double digits. Regardless of the long-term effects of Reagan's vaunted supply-side tax incentives (such as they are), the short-term effect is sure to be hard-to-finance budget deficits. In order to elicit the kind of economic boom that the administration has heralded for its program, the Federal Reserve will come under heavy pressure to bring its interest rates down in the midst of strong pressures for monetary expansion.

So, while the short-term outlook for key foreign currencies remains bearish, the longer term outlook is quite different. Clearly, the unit with the best potential (as always) is the Swiss franc. Ironically, although its currency has suffered most over the last two and a half years, Switzerland has the strongest economy.

Thanks to the franc's depreciation, which in real terms is more like 35 percent, Swiss exports are booming. The Swiss economy, which had been excessively stimulated by an expansive monetary policy, is now slowing down as the Swiss National Bank tightens credit and raises interest rates. As a result, inflation should begin to recede from its recent 6 percent level. With practically zero unemployment, reducing inflation and strengthening the franc should present none of the ticklish political tradeoffs facing Germany and others.

One of Europe's foremost economists told me that the Swiss franc (and to a lesser extent the German mark) are due for a major bullish correction later this year. Hans Mast, chief economist for Swiss Credit Bank, predicted a "noticeable firming" of the franc by year-end. He asked that his specific exchange rate forecast not be quoted because "it would shock everybody today." Indeed it would!

Not only is the Swiss central bank trying "to achieve a certain appreciation of the Swiss franc…to lower import costs and to dampen the export boom," but foreign investors and bankers are once again beginning to look on the franc with favor, according to Dr. Mast. As US interest rates begin to fall, while Swiss rates rise, said Mast, "there comes a point when investors say, 'Why should I stay in US dollars with practically no real rate of return, when at the same time I'm receiving in Switzerland a quite appreciable real rate of return?'"

Of course, Mast's prognostications assume not only a diminishing interest rate differential but also a widening inflation differential—quite the opposite of what is now occurring. Mast's views find surprising concurrence among other leading economists and bankers in Europe. But it would be a mistake to bet whole-heartedly against the dollar.

Positions in Swiss francs and other units should be regarded either as a fractional hedge against high-yielding dollar positions or as a long-term speculation. It's not a sure thing, but there is a strong probability that, without returning to its old high, the Swiss franc will rebound substantially from present lows. Therefore, placing perhaps 10 percent of a portfolio in that currency makes sense.

How do you do it? Well, don't go out and buy Swiss franc banknotes and sit on them. Your realistic alternatives, depending on your means and your risk-taking proclivities, are Swiss franc deposits (preferably three- or six-month certificates of deposit) or futures contracts.

Recently, three- and six-month Swiss franc CDs were yielding 7-1/8 percent at a typical Swiss bank for a minimum investment of $5,000. That rate may rise or fall, but the risk is low, and if you are willing to roll them over indefinitely, there is a good chance that over the next two years you will catch a wave of franc appreciating that will dwarf the interest you are earning.

Alternatively, take a long position in Swiss franc futures contracts on the International Monetary Market (IMM) in Chicago. The current minimum exchange margin on a Sfr 125,000 contract is $2,000. Each one-cent change earns (or loses) you $1,250.

No one knows when Paul Volcker will relent on interest rates or when US inflation will rise again, setting off the overdue correction. Therefore, probably the best strategy is to take positions in distant delivery months—as much as a year out. If you can afford it. Such a strategy requires having enough additional money in your account to ride out dips and resultant margin calls in expectation of a longer-term rise. If you can't afford such a strategy or if you think you're astute enough to trade shorter-term, then at least employ stop-loss orders 10-20 points below your entry point.

At this writing, there was evidence of a flight of French francs into Swiss francs in the wake of the Mitterrand election. And the Swiss National Bank has raised its Lombard rate a full point. A change in fundamentals on either side of the Atlantic in Switzerland's favor may be all that's needed to spark the next big move of the Swiss franc.

Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.

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MONEY QUESTION Q: I have not as a rule invested in real estate, but I understand there could be some advantages in buying my parents' house. This could not only provide me with some investment property and tax deductions but, if they financed the loan, could provide them with some interest income in their retirement. Perhaps you would discuss this in your column or provide me with a source of information on the subject.
L.B., Great Falls, VA

A: What you are suggesting sounds sensible to me, but I don't know all the ramifications. I suggest you refer to Albert J. Lowery's books on the subject.