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I am curious what effect currency devaluation has on the value of my various investments/assets.

For instance, I have retirement savings in mutual funds, growth stocks, and bonds. First, let's consider mutual funds that do not contain government bond shares. It seems to me that these assets should be relatively immune to currency devaluation, because I own a number of shares of different companies, rather than an amount of dollars. Thus, if the companies whose stocks I have shares of have invested wisely, the stocks' real values would stay relatively the same (and value would increase with respect to the currency), while government bond assets' real values would decrease.

Now, my gut tells me that this is probably incorrect. Can somebody clarify this for me? I want to know if I need to be making sure my investments span multiple currencies to protect against a single country's currency failing.

I would ask the same question about my home's value against a devalued currency as well. Would it keep the same real value.

Now, I'm mainly wanting to get a picture of the affect the currency devaluation has on the values. I know that there could be some downstream effects where the economy suffers such that the demand for housing goes down, causing decreased value. If you have simple examples of those downstream effects that would be great, but I'm mainly curious about the immediate effects of the currency devaluation itself.


UPDATED QUESTION SUMMARY: I'm really interested in what happens when a currency quickly devalues. For example, treasury bonds are tied to the currency, so the real value would exactly follow the devaluation. On the other hand, a commodity, like gold, is not tied to the value of any currency. Thus, it is theoretically immune to the devaluation and its real value would remain constant.

My question boiled down: Do stock mutual funds behave more like treasury bonds or commodities? When I think about it, it seems that they should respond the devaluation like a commodity. I own a quantity of company shares (not tied to a currency), and let's assume that the company only holds immune assets. Does the real value of my stock ownership go down? Why?

Please don't over-complicate the question, arguing about how nothing is truly immune or stable.

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    Just a pedantic nitpick about your choice of words: When we talk about inflation, it's usually with respect to prices inflating. It wouldn't be the currency inflating. Each unit of currency would buy less stuff. One might say the currency is devalued in the face of price inflation. – Chris W. Rea Sep 24 '13 at 19:15
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    @ChrisW.Rea I'm shamelessly editing a comment about that into my answer, because it's a great point. Please feel free to edit as you see fit, however. The clearer the better! – John Bensin Sep 25 '13 at 2:33
  • I apologize for using the term "currency inflation" when I meant "currency devaluation". I have edited the question to reflect the intended meaning. – mattgately Sep 27 '13 at 18:37
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    There is something to be said for what kinds of stocks are referencing here as big multinational companies are different from foreign companies and different from small companies where the business may be localized. This also can color the results I'd argue. – JB King Sep 27 '13 at 19:01
  • Great question and appreciate everyone's explanation. In particular, John Bensin's explanation helped me a lot. Thanks John! I also found a good explanation at : investopedia.com/articles/forex/080613/… – Joe Black Dec 11 '16 at 11:35
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Stocks, gold, commodities, and physical real estate will not be affected by currency changes, regardless of whether those changes are fast or slow. All bonds except those that are indexed to inflation will be demolished by sudden, unexpected devaluation.

Notice: The above is true if devaluation is the only thing going on but this will not be the case. Unfortunately, if the currency devalued rapidly it would be because something else is happening in the economy or government. How these asset values are affected by that other thing would depend on what the other thing is. In other words, you must tell us what you think will cause devaluation, then we can guess how it might affect stock, real estate, and commodity prices.

  • I think this answers the question I have regarding the devaluation of the currency independent of what other factors may be going on in the economy. Specifically, I was thinking about economies which have their currency not backed by anything and perhaps no laws or rules in place to guarantee intentional devaluation, so the money manager could devalue the currency in isolation, by simply printing more currency. Now, how the rest of the market responds to such an action is a completely different question. – mattgately Jul 29 '16 at 13:46
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First, a clarification. No assets are immune to inflation, apart from inflation-indexed securities like TIPS or inflation-indexed gilts (well, if held to maturity, these are at least close). Inflation causes a decline in the future purchasing power of a given dollar1 amount, and it certainly doesn't just affect government bonds, either. Regardless of whether you hold equity, bonds, derivatives, etc., the real value of those assets is declining because of inflation, all else being equal.

For example, if I invest $100 in an asset that pays a 10% rate of return over the next year, and I sell my entire position at the end of the year, I have $110 in nominal terms. Inflation affects the real value of this asset regardless of its asset class because those $110 aren't worth as much in a year as they are today, assuming inflation is positive.

An easy way to incorporate inflation into your calculations of rate of return is to simply subtract the rate of inflation from your rate of return. Using the previous example with inflation of 3%, you could estimate that although the nominal value of your investment at the end of one year is $110, the real value is $100*(1 + 10% - 3%) = $107. In other words, you only gained $7 of purchasing power, even though you gained $10 in nominal terms.

This back-of-the-envelope calculation works for securities that don't pay fixed returns as well. Consider an example retirement portfolio. Say I make a one-time investment of $50,000 today in a portfolio that pays, on average, 8% annually. I plan to retire in 30 years, without making any further contributions (yes, this is an over-simplified example). I calculate that my portfolio will have a value of 50000 * (1 + 0.08)^30, or $503,132. That looks like a nice amount, but how much is it really worth? I don't care how many dollars I have; I care about what I can buy with those dollars.

If I use the same rough estimate of the effect of inflation and use a 8% - 3% = 5% rate of return instead, I get an estimate of what I'll have at retirement, in today's dollars. That allows me to make an easy comparison to my current standard of living, and see if my portfolio is up to scratch. Repeating the calculation with 5% instead of 8% yields 50000 * (1 + 0.05)^30, or $21,6097. As you can see, the amount is significantly different. If I'm accustomed to living off $50,000 a year now, my calculation that doesn't take inflation into account tells me that I'll have over 10 years of living expenses at retirement. The new calculation tells me I'll only have a little over 4 years.

Now that I've clarified the basics of inflation, I'll respond to the rest of the answer.

I want to know if I need to be making sure my investments span multiple currencies to protect against a single country's currency failing.

As others have pointed out, currency doesn't inflate; prices denominated in that currency inflate. Also, a currency failing is significantly different from a prices denominated in a currency inflating. If you're worried about prices inflating and decreasing the purchasing power of your dollars (which usually occurs in modern economies) then it's a good idea to look for investments and asset allocations that, over time, have outpaced the rate of inflation and that even with the effects of inflation, still give you a high enough rate of return to meet your investment goals in real, inflation-adjusted terms.

If you have legitimate reason to worry about your currency failing, perhaps because your country doesn't maintain stable monetary or fiscal policies, there are a few things you can do. First, define what you mean by "failing." Do you mean ceasing to exist, or simply falling in unit purchasing power because of inflation? If it's the latter, see the previous paragraph. If the former, investing in other currencies abroad may be a good idea. Questions about currencies actually failing are quite general, however, and (in my opinion) require significant economic analysis before deciding on a course of action/hedging.

I would ask the same question about my home's value against an inflated currency as well. Would it keep the same real value.

Your home may or may not keep the same real value over time. In some time periods, average home prices have risen at rates significantly higher than the rate of inflation, in which case on paper, their real value has increased. However, if you need to make substantial investments in your home to keep its price rising at the same rate as inflation, you may actually be losing money because your total investment is higher than what you paid for the house initially.

Of course, if you own your home and don't have plans to move, you may not be concerned if its value isn't keeping up with inflation at all times. You're deriving additional satisfaction/utility from it, mainly because it's a place for you to live, and you spend money maintaining it in order to maintain your physical standard of living, not just its price at some future sale date.

1) I use dollars as an example. This applies to all currencies.

  • It seems that your response has to do with the ordinary devaluation of currency over a long time period and what that means in future dollars versus today's dollars. I'm actually more interested in what happens when a currency quickly devalues. See my question edit. – mattgately Sep 27 '13 at 18:58
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    @mattgately Unfortunately, this is a complicated question. Stock prices are definitely affected by currency devaluation, because (for example), currency devaluation can affect a country's trade balance, which can in turn affect the growth of the economy, thus affecting companies. Furthermore, companies have debts that are denominated in nominal terms, so changes in the real value of a currency (compared to another currency, for example) can affect their ability to pay back those debts and access further lines of credit. – John Bensin Sep 27 '13 at 20:38
  • @mattgately Although it's not the answer you want to heare, assets aren't immune to currency devaluation. Such devaluation is endogenous to the economy, and can affect other parts of the economy in numerous ways, which in turn can affect the value of the currency in a feedback effect. The reality is that modern economies are intricately connected and exceedingly complex. – John Bensin Sep 27 '13 at 20:40
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My question boiled down: Do stock mutual funds behave more like treasury bonds or commodities? When I think about it, it seems that they should respond the devaluation like a commodity. I own a quantity of company shares (not tied to a currency), and let's assume that the company only holds immune assets. Does the real value of my stock ownership go down? Why?

  1. Have you researched the Peso crisis in the 90s? A snippet:

On December 20, 1994, newly inaugurated President Ernesto Zedillo announced the Mexican central bank's devaluation of the peso between 13% and 15%. Devaluing the peso after previous promises not to do so led investors to be skeptical of policymakers and fearful of additional devaluations. Investors flocked to foreign investments and placed even higher risk premia on domestic assets. This increase in risk premia placed additional upward market pressure on Mexican interest rates as well as downward market pressure on the Mexican peso. Foreign investors anticipating further currency devaluations began rapidly withdrawing capital from Mexican investments and selling off shares of stock as the Mexican Stock Exchange plummeted. To discourage such capital flight, particularly from debt instruments, the Mexican central bank raised interest rates, but higher borrowing costs ultimately hindered economic growth prospects.

  1. I reference the above because your question actually has another question implied in it: "How will other market participants respond?" It's not just you and your investments, but others and their investments. If the US Dollar was devalued by 50%, all of your investments tied to the Dollar would be down that much; example, a US index fund in Dollars will be devalued by 50% because the principal in Dollars is halved in value. Now, others may rush into the stock market in a panic to avoid cash, causing the market to rise, or some businesses that profit from a weaker Dollar may see a huge increase in profits, increasing the demand for their stock, but the Dollar principal of your investments will be halved in this example.

The question is how would they pull this off if it's a floatable currency. For instance, the US government devalued the US Dollar against gold in the 30s, moving one ounce of gold from $20 to $35.

The Gold Reserve Act outlawed most private possession of gold, forcing individuals to sell it to the Treasury, after which it was stored in United States Bullion Depository at Fort Knox and other locations. The act also changed the nominal price of gold from $20.67 per troy ounce to $35.

But now, the US Dollar is not backed by anything, so how do they devalue it now (outside of intentionally inflating it)? The Hong Kong Dollar, since it is fixed to the US Dollar, could be devalued relative to the Dollar, going from 7.75 to 9.75 or something similar, so it depends on the currency.

As for the final part, "does the real value of my stock ownership go down" the answer is yes if the stock ownership is in the currency devalued, though it may rise over the longer term if investors think that the value of the company will rise relative to devaluation and if they trust the market (remember a devaluation can scare investors, even if a company has value).

Sorry that there's too much "it depends" in the answer; there are many variables at stake for this. The best answer is to say, "Look at history and what happened" and you might see a pattern emerge; what I see is a lot of uncertainty in past devaluations that cause panics.

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