There Be No Shelter Here

Little is asked of a reserve currency other than that it hold its value and remain widely accepted for the purchase of internationally traded goods such as oil, ore, and food. Despite these minimum standards, there are only four currencies in the world today that meet the criteria: the U.S. dollar, the euro, the British pound, and the Japanese yen.

Of that select group, the dollar is by far the most preferred denomination. According to IMF data, more than 60% of the world's foreign exchange reserves are based in dollars. The next most popular reserve currency is the euro, with a little less than 30% of reserves, though it's been gaining on the dollar in recent years as skeptics around the world begin to fear the U.S. government's accumulating debt and growing deficits. Far behind that are the yen and the pound, with less than 5% of reserves.

But that's it. That's the menu if you're looking for a low-risk vehicle for your savings, and frighteningly -- I'm bearish on all four of them.

Let's start with the dollar
I've been predicting the demise of the dollar for more than a year now. The evidence for this is that the Congressional Budget Office expects our federal budget deficit to exceed $1.3 trillion this year, or more than 9% of GDP. While not yet more than the 12% of GDP that has some predicting the demise of Greece, the size of our current deficit is troubling for a country that would like to continue to benefit from being the world's reserve currency. The CBO also projects our national debt at $8.8 trillion, or 62% of GDP by the end of the year. While not yet in outright crisis territory, it's going to take some hard decisions by the government to rein in that number -- decisions I'm not confident our elected officials will make.

What that means is that we're likely to turn on our printing press to meet our obligations, thereby devaluing the dollar. This will annoy the 62% of the world that's holding their currency reserves in dollars and prompt them to find alternative means to hold their savings, leading to further weakness in the dollar. Thus, one doesn't want to be caught holding nothing but dollars as these events take place.

Of course, I'm being proved wrong
Yet while the dollar did weaken 10% against the euro for most of 2009, making good money for holders of CurrencyShares Euro Trust (NYSE: FXE  ) , the trade has reversed in 2010 with the dollar almost reclaiming its January 2009 levels. The world is fast realizing that Europe's troubles are even more dire than our own.

Take, for example, the continent's recent experience with Greece, which has $25 billion in debt due by the end of May and another $152 billion due between 2011 and 2014, with a very questionable ability to make those payments on its own. Similar problems lie in wait for other European economies such as Portugal and Spain. While it had previously not been clear what, if anything, the European Union would do to support these member states, the recent EU/IMF framework agreed to by the continent's presidents shows that the EU will step in and assist member states in financial need. Thus, Greece's balance sheet is also the euro's balance sheet -- an unsettling prospect for risk-averse investors.

This has explained the recent flight from the euro, and because currency values are relative, another currency has to strengthen in order for the euro to weaken. Since there are only two major reserve currencies (really, Britain and Japan have bigger problems and less liquidity than the U.S. and Europe), the U.S. has benefited from Europe's troubles even though we've done nothing to solve our own underlying financial problems.

This cannot last
Being less bad than very bad, however, is not a sustainable solution, and the dollar remains a ticking time bomb within investments such as Treasuries and high-grade bonds that many investors consider lower risk. But if investors shouldn't be in the dollar, the euro, the pound, or the yen, then where the heck should they be?

This is a tricky question. One answer, of course, is gold, and that's why gold prices, vehicles such as SPDR Gold Shares (NYSE: GLD  ) , and miners such as Barrick Gold (NYSE: ABX  ) , remain at or near record highs. However, gold can't keep going up and up and up. As Warren Buffett famously remarked about the precious metal, "It has no utility."

This doesn't mean gold should be expunged from a diversified portfolio, but only that it should remain just a part of a diversified portfolio.

The prospects for other currencies
Longer term it's inevitable that the world's large emerging economies will see their currencies strengthen against the dollar as they develop and investors reassess their risk profiles. Ultimately, currencies such as the Brazilian real, Chinese yuan, and Indian rupee may become credible reserve currencies.

In the here and now, however, these countries remain too volatile both politically and economically for their currencies to reliably hold their value (the most important characteristic of a reserve currency). Further, in the case of China, we're looking at years before that country allows its currency to strengthen due to its reliance on export manufacturing -- as I wrote in last week's column.

In other words, while investors are smart to have some exposure to each of these countries, one would not want a portfolio devoted 100% to any of them. There's just too much uncertainty.

The solution
All told, there is no one safe haven in which to denominate your investments today -- not the dollar, not the euro, not gold, and certainly not Ukrainian hryvnia. The solution, then, is diversification, and you want a smattering of currency and commodity exposure in your savings in order to protect yourself from looming volatility.

Philip Morris International (NYSE: PM  ) is a stock we like at Motley Fool Global Gains in this regard, not only because it provides global currency exposure, but also because it sells a product (cigarettes) whose price should keep pace with the rate of inflation ... whatever it may be. Other companies that meet these criteria are multinationals such as Coca-Cola (NYSE: KO  ) and Yum! Brands (NYSE: YUM  ) .

The takeaway, though, is that these are volatile times the world over, and you won't find shelter for your portfolio in any one company, currency, country, or asset class. Tread carefully.

Get Tim Hanson's Global View column every Thursday on Fool.com, or by following him on Twitter.

Tim Hanson is co-advisor of Motley Fool Global Gains. He owns shares of Philip Morris International, which is a Global Gains recommendation. Coca-Cola is both an Inside Value and an Income Investor recommendation. Motley Fool Options has recommended a bull call spread position on Yum! Brands. The Fool's disclosure policy notes that the title of this article is not grammatically incorrect, but rather pays homage to a song by Rage Against the Machine.


Read/Post Comments (6) | Recommend This Article (27)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 08, 2010, at 6:16 PM, RegLeCrisp wrote:

    Gold has as much utility AS IS ASCRIBED TO IT, much like any fiat currency. But how do you prop up a fiat currency? Back it with gold! The paradox of Buffet's statement is compelling unless what he is really saying is that he is shorting USD like a maniac. Check out who owns the largest percentage of GLD by the way ...Paulson and Soros. I wouldn't call these guys gold bugs, but I believe they understand the intrinsic value of gold will trump the instrinsic value of the dollar for the foreseeable future. Granted, as an investment idea it is weak (for the majority of us), as a hedge it is unbeatable along with the multination dividend plays mentioned (as well as some unmentioned pure interational dividend payers, preferably non-EUR).

  • Report this Comment On April 09, 2010, at 9:59 AM, greenvillewolf wrote:

    This article should be required reading for Obama and all other other dunces in Washington. Of course, most of them are probably too freaking stupid to understand it.

  • Report this Comment On April 09, 2010, at 12:13 PM, nemaline wrote:

    Nice Rage Against the Machine reference, Tim!

  • Report this Comment On April 09, 2010, at 12:21 PM, nemaline wrote:

    Tim,

    I like the Rage Against the Machine reference!

    nemaline

  • Report this Comment On April 09, 2010, at 1:36 PM, rfaramir wrote:

    "gold can't keep going up and up and up"

    Really? Up against what? Fiat currencies. What is the limit of their going down? There is no limit to that, therefore there is no limit to gold going up.

    That said, "going up" is relative. Gold is 'only' a store of value (informal currency, formerly real money). Businesses that make products (or to a lesser extent services) that consumers demand actually create wealth. They are generally a better investment.

    But for the part of your portfolio that would otherwise be cash, invest in gold (and silver), instead.

  • Report this Comment On April 13, 2010, at 12:17 PM, ConsiderThis1 wrote:

    There is only one true currency in the world: our Labor. Or more precisely, the products from our productivity and labor. I will collectively call this "labor-produce".

    Everything else is fiat-like in comparison, even gold.

    Unlike fiat-like currencies, If our labor-produce doubles, we've doubled the collective wealth (your share of the wealth is another matter). The same is not true of currencies, or gold (i.e. if a gold asteroid fell to Earth and doubled the available gold on Earth, we will be no richer, no poorer.)

    Keep this in mind when you hoard anything, be it gold, metal, oil, etc. Keep your eye on the one true currency.

    For when a crisis brews that disrupts our ability to create said "labor-produce", there'll be flux and adjustments in every man-made measurement yardstick (currency, stock index, gold, inflation, etc), but collectively we're all poorer no matter which yardstick you use.

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