What Do Reserve Currencies Mean To You?

By Apr 6, 2012, 7:29 AM Author's Blog  

Yesterday FT Alphaville had a short bit about whether the Australian  dollar was becoming “a” reserve currency. I put “a” in quotes because it would be hard to figure how there would be a bunch of reserve currencies–if there were, then it would be a different concept which is what the world might need.

The reason the Aussie can’t be the world currency is that it is too small. There was a stretch there where people thought the Swiss franc should play into this equation but it too is too small. All of them are too small to be a reserve currency, as we now use the term, except for maybe the euro but that seems very unlikely to occur given what a mess the continent is. Again maybe the entire concept should change; maybe the Brazilian real should be some sort of benchmark for Latin America, the Aussie for Oceania and so on.

In relating this to what an individual investor should do I think about a couple of different things. One is the Nassim Taleb concept that I first mentioned a few years ago about having 90% of the portfolio in t-bills from around the world and then going berserk (my word. not his) with risk with the other 10%.

His idea was to be country agnostic by holding currency in one form or another from many different countries to avoid some sort of black swan taking down the one country that you might be home biased in or some sort of predictable event taking down one single country. I first started using foreign t-bills and currency ETFs in client accounts in 2006 but nowhere near the proportion that Taleb talked about. We do a little more with this than we used and will probably increase this some in the future with more t-bill or note exposure.

This sort of exposure was obviously going to get easier to access and this has been the case. WisdomTree, PIMCO and iShares have come out with products that target various foreign bond market segments and average maturities and of course there are quite a few currency ETFs. If I had to guess however I think the ETF industry is less interested in currency funds than bond funds.

The New Zealand dollar won’t ever be a reserve currency but there are some favorable attributes and depending on portfolio size it would be possible to add exposure. I think there are currency accounts where as little as $10,000 will allow for holding a currency and although bond minimums tend to be around $100,000 this will come down if it hasn’t done so already in some places.

Bigger picture this is a world getting flatter/US becoming a little less relevant portfolio concept. The idea of home bias is not new here. I’ve told the story about being on a panel at a conference with someone from Turkey who said 15-20% in the home market (that being Turkey) was typical. If the world is getting flatter then moving closer to the Turkey example is plausible. I’m not saying 15% domestic will ever make sense but I have been saying that less domestic exposure than people had in the 1990s does make sense.

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