September 19, 2003
Hedging the Dollar
Brad DeLong, who I've known since grade school and who writes a wonderful semi-daily journal, does not hedge as he puts into words something I've been wondering about for a couple of weeks: "why foreign exchange traders, gibbering in terror as they look at the U.S. trade deficit, haven't dumped the dollar, pushing it down in value". My answer to that question might lean a bit more on the traders' belief that the Euro isn't yet a reliable reserve currency -- maybe there's a shortage of perfect substitutes for the dollar. But if that's right, it also follows that it should be a major objective of US fiscal policy to ensure that the dollar remains more attractive than the Euro. Even a partial switch to the Euro would be a catastrophic event (in both senses of the word). The Bush administration's complacency on this issue appears to have one or more of these three causes: lack of imagination, lack of intelligence (that seems to be Brad's guess), or the completely mendacious short-termism more commonly associated with barbarians looting the city.
But enough theory. Suppose I believe that the dollar is over (or under) valued. Short of buying foreign currency at ruinous bank rates, which then would require an account to hold them, or buying short term currency futures which expire too fast, what sort of foreign-currency-denominated asset is there that I can acquire on reasonable terms (small lots, low transactions costs)? Who markets currency hedges to households? Any single foreign stock or bond is too risky, if only because I am too ignorant to pick one. And the so-called foreign-currency bond funds on offer that invest in the major stable currencies (as opposed to emerging market funds) seem, when you look at them carefully, to hold amazing amounts of US government bonds. Many of them are also set up in ways that appear designed to allow speculation on medium- to long-term interest rate differentials rather than currency rates -- you buy a dollar's worth of the fund, and the price stays fixed, with returns fluctuating over time primarily as a result of changes in interest rates. Is there a market opportunty here, or is it already filled?
Posted by Michael : September 19, 2003 12:45 PM
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RPIBX seems to stick to its knitting pretty well (95% in foreign bonds as of 6/30/03). And although it has the authority to hedge currencies, traditionally, it has not attempted "to cushion the impact of foreign currency fluctuations on the dollar" and prides itself on being "heavily exposed to foreign currencies."
Did you look at this fund? What did you think of it?
Posted by: Ellen1910 at September 22, 2003 02:24 PMAh. The "the euro isn't a reserve currency, so we have to hold dollars" argument...
The neoclassical economist who dwells in my brain wants to say that this cannot be true in theory. More than 200 million people--rich people--buy things with euros every day. The value of the euro is set by the most rabidly-anti-inflation central bank that ever was. Theory tells us that the euro is a *fine* reserve currency. And since it is true in theory, it must be true in practice.
Perhaps it's time to tell the neoclassical economist who dwells in my brain to stop barking and go to his kennel...
Posted by: Brad DeLong at September 22, 2003 11:13 PM"Any single foreign stock or bond is too risky, if only because I am too ignorant to pick one."
You can invest in iunits on the Toronto Stock Exchange. These are exchange traded funds that replicate various market indices (i.e. S&P / TSE 60). I'm guessing here, but there are probably similar instruments available on US exchanges to replicate Euro / Asia-Pacific investments.
Posted by: Bill at October 20, 2003 04:05 AMI have deleted a piece of comment spam that used to be here. It was hawking medicine, much like Bob Dole....
Posted by: Michael at December 2, 2003 01:54 AM