Over the past few weeks I have been asked by clients and prospective clients if they should be buying United States dollars.
At present, the cross rate is $NZ1 for US75c.
The simplest way for individuals to purchase and hold US dollars is to open an offshore account at the major trading banks and some sharebrokers offer accounts as well. Your New Zealand dollars are converted to the foreign currency and you receive interest at the foreign country's call rate.
In the case of US dollars the interest rate is about 0.1%. For euros it is 0.5%.
No interest is currently being paid on Japanese yen, Hong Kong dollars or Swiss francs. Currency gains made on offshore accounts are taxable as income.
The theory is that you buy the currency and then wait for the New Zealand dollar to decline.
In my opinion it is a dangerous game.
Over the past two years the trend has been for the US dollar to weaken in relation to the New Zealand dollar. This is not because the New Zealand dollar has strengthened but because the US dollar has been progressively weakened by the US Government's fix-it programme of issuing debt by generated money.
The more money there is in circulation the weaker the currency.
Since March 2009 the cross rate has risen from US49c to the present US75c.
The trend is still in this direction and in my opinion the chance of a reversal is some way off.
At the same time there is a worldwide currency war raging, with China and the United States the main players, but it is affecting emerging countries such as Brazil.
The problem is the imbalance of wealth, with many countries such as China and Germany having huge reserves of capital.
As at September 30, 2010, China had $US2.6 trillion ($NZ3.48 trillion) in foreign currency reserves and by the end of next year will most likely have grown them to $US3 trillion.
China's currency is considered to be undervalued and it is unwilling to let it rise in relation to other currencies.
It invests in other countries' debt (bonds) but will not allow foreigners to buy its own.
China earlier this year purchased up to $US25 billion over time of Japanese debt, which drove the value of the yen up about 15% against the US dollar.
The United States wants China to stop pegging the yuan and let it float. However, China sees that easing of the yuan will create a gross distortion in the world economy as investors rush elsewhere.
The emerging countries then have to deal with the problem of high capital flows that may only be temporary and cause wild swings in their currency.
Brazil attempted to counter the inflows by doubling a tax on foreign purchases of its debt.
If the flow of foreign currencies into emerging markets increases they will have to take measures such as capital controls on volume and taxes as Brazil has done or just let their economies overheat.
Either way they lose their competitiveness for exporting, which is what they need to keep their economies ticking over.
This means the US dollar is more likely to continue weakening rather than strengthening in the short term as there may be a trade war between countries such as China and the US. The US is expected to continue printing money to ease its problems and China is in no hurry to allow the yuan to strengthen.
From a New Zealand dollar perspective you might be better in the short term to consider holding the euro or sterling, but that is a whole new newspaper article.
(The author acknowledges information from The Economist of October 14 used in this article.)
Peter Smith is a certified financial planner and the principal of Peter Smith Financial Services Ltd, Dunedin. Email: finance@petersmith.co.nz. A free disclosure statement is available on request.
