What currency should we be saving?

Colin Bloodworth , Jakarta Post

This is probably one of the questions I am most frequently asked.

The simple answer is that we should be accumulating wealth in the currency of end use. In other words, if you are a U.S. national and you are planning to return to the U.S. you should be saving U.S. dollars. If you are British it should be pounds sterling, if Australian, Aussie dollars, and so on.

What if your base currency is rupiah?

If you are Indonesian then naturally this is your base currency and the one you would expect to hold.

Many expatriates plan to make Indonesia -- perhaps Bali -- their permanent or eventual home so should they also be building up their wealth in Rupiah?

This is where the base currency principle breaks down since the rupiah is prone to devalue over the long term. When I first came to Indonesia in 1983 the exchange rate was Rp 600 to US$1.

As the rate today is around Rp 9,000 that represents a 1,500 percent devaluation over 24 years. If it continues to devalue at the same rate over the next 24 years the exchange rate will be Rp 135,000 to the $1 in the year 2031.

(You may wish to cut this article out and compare the actual rate in 2031!)

Now, before you rush off to convert all your rupiah to dollars, bear in mind that the trend is a long-term one. In the short term the rupiah can hold its value for a number of years and under a stable government such as at present, could even appreciate.

But if you are looking long-term then it would be wiser to hold a "hard" currency. The U.S. dollar is not necessarily the only one to consider.

When do devaluations hurt?

A gradual devaluation can actually be beneficial to a country as it helps its exports to be competitive. Devaluations hurt when they are sudden and severe.

It is now 10 years since the Asian financial crisis broke. At first it affected only Thailand but the domino effect soon dragged Indonesia into the abyss and it ended up suffering more than the other countries and eventually resulted in the collapse of the regime.

The rupiah fell from around Rp 2,500 to $1 to as low as Rp 15,000 at one stage. Expatriates paid in foreign currencies enjoyed a brief windfall as they were able to snap up bargains in rupiah before reality caught up.

For many, their windfall was short-lived as they became too expensive to employ. Expat hotel managers, executive chefs, English language teachers and others on local contracts left Indonesia in droves.

Their numbers have never recovered, to the chagrin of landlords who could once demand three years' sky-high rent -- in cash, in advance.

But how did the devaluation affect the Indonesian farmer in the rice fields or the average employee in the city?

They would certainly have had no understanding of foreign exchange. The impact on them was even more devastating because the cost of goods and services rocketed as a result of the weak currency.

Hundreds of thousands found themselves unemployed. Today, the economy has recovered substantially, wages have caught up and easy loans have created a boom in domestic spending, although millions have yet to share the benefits.

We are unlikely to see a repeat of 1997 but a hard lesson was learned by many.

Could the U.S. dollar collapse?

There are the odd commentators who consider the dollar could go through the floor. Although rupiah-watchers tend to compare rupiah with dollars there has not been significant movement of late but both currencies have actually fallen against stronger currencies such as the British pound, the euro and the Aussie dollar.

The U.S. dollar could indeed fall further for several reasons, among them the long-standing and massive budget and trade deficits, plugged only by continuing inflows from cash-rich countries.

Then again, it is likely that interest rates in the U.S. will start falling before those of other Western countries. These arguments are logical, but logic does not always apply.

Countries like China and Japan would stand to lose heavily if the dollar fell due to their huge reserves in the currency.

Nevertheless, it is evident that a shift to other currencies is taking place so the days of the all-dominant U.S. dollar could be numbered.

The message here for the small investor is that if you do not have a single, solid base currency then it would be wise to diversify your currency holdings.

What if you are paid in U.S. dollars?

With the exception of those hired locally most Western expatriates are paid in U.S. dollars, even though the majority are not American.

Consequently, over the years, expatriates have tended to build up their savings in dollars. Another justification is the fact that there is a much larger universe of funds in U.S. dollars and it cannot be denied that big business is dominated by American companies.

With the slide in the dollar over the past few years, however, many people are questioning the wisdom of holding dollars when they are falling in value against their home currency.

Cash is not risk-free

There is a common misconception that keeping money in the bank is safer than investing it. Those who mistimed the stock markets will never be convinced otherwise!

But it is actually high risk in two respects; first, cash is unlikely to hold its purchasing value over time and second, the currency of your cash deposit could lose its value against other currencies.

A few years ago someone told me he was not interested in investing and kept all his money in U.S. dollars (the currency he was paid in) in a deposit account.

He thought his money was safe but in fact he lost 40 percent in less than three years. How could that be? No-one stole money from his account but the fact is he was European and in euro terms the value of his deposit fell 40 percent.

Indeed, over a period of years even major currencies can swing wildly against each other. When the euro was launched in 1997 it was valued at 1.17 to US$1.

Within a couple of years it had fallen to 0.80 but now it has shot up to 1.34. So playing the currency game can bring rich rewards or heavy losses!

What currencies should we choose?

In the short term you need to hold a certain amount of cash in whatever currency you have commitments. If you have a business with local staff to pay then it makes sense to keep funds in a rupiah deposit.

Even if there were a devaluation it would be some time before wages adjusted. But in the longer term you need to keep in mind the tendency of the currency to fall.

If you are an expatriate then you should be building up assets in the currency you expect to eventually use. It may not prove to be the strongest currency but it is less risky that having all your money in the wrong currency.

Some currency diversification may be justified. You will probably always need to have some holdings in U.S. dollar funds due to the dominance of U.S. companies.

If you plan to settle in Indonesia or are not certain where you might settle then you need rupiah for the short term and a mix of major currencies for the long term.

Perhaps more importantly, you need to be invested in solid assets, including equities, real estate and commodities, as they can protect you against a falling currency.

What about gold?

Gold was a major currency in ancient times and it is still seen today as a safe haven in times of global unrest. It also has a place as a reserve currency, there is constant demand from the jewelry trade and its supply is finite.

If you have ample holdings in cash, stocks, real estate and other assets there is no harm in holding up to 5 percent of your assets in gold and precious metals. They can be easily accessed via mining funds or bullion funds without having the headache of taking physical delivery.

Men may find that their wives quite like the idea of investing in gold if it comes in the form of jewelry. I would not like to be around as your financial adviser, however, when the markets dictate that profits should be taken and the asset sold!

Colin Bloodworth is a senior financial adviser with Financial Partners International. If you have any questions relating to personal finance you may contact him at tel. 5208099 or e-mail: colin.bloodworth @financial-partners.biz.