* WHAT TO DO NOW: Expand your currency horizons. We live in a global economy and must understand more than our own currency. This lesson we continue our study of one of the three most important currencies in the world, the German mark. See below.
* EZ CURRENCY DIVERSIFICATION: Gain contacts to diversify into the German mark on page five.
* EZ CURRENCY SAFETY: Diversify into at least three currencies, the U.S. dollar, German mark and Japanese yen. Our review of the yen begins on page six.
They are noisy speakers that issue strange sounds. There is movement, motion and crowds. People bumping, pushing yet I suddenly feel alone. All is busy, alien and hard to understand. This is my first foreign port, and already I am confused.
Haneda Airport 1968. I am flying abroad for the first time from Portland, Oregon to Vancouver, Canada, then on to Hong Kong via Japan. The plane touched down in Tokyo and I am wandering through the transit lounge. There are so many sights and sounds that are strange to me. Plastic samples of meals sit in the restaurant windows and the brands are those I have never heard. I step to the bar and am offered a Kirin beer or a Suntory whisky. "Are they good?," I ask. "Of course," is the reply. "How much do they cost?," I ask. "Just divide the price by 400 and you will have the dollar price," I am told. "One dollar is 400 yen!"
Had I only known then that the yen would rise in value over the next 27 years to reach a high of 79 yen per dollar, I imagine I would have purchased as many yen as possible. But no one could have convinced me then, and worst still no one knew. Later in this lesson we will look at why the yen has risen to such mighty heights, but first let's continue our examination of the world's other strong currency, the German mark.
The table next page, supplied by the Bundesbank, shows foreign exchange rates for many different currencies against the Deutsch mark. Since the table was supplied by the Bundesbank, it is in German. The names of the currencies appear at the top, with a year-by-year price of the currency in terms of DM. For instance, the first column shows how many DM one U.S. dollar would buy in every year since 1953. In 1953, one U.S. dollar bought 4.200 DM. By 1993, one U.S. dollar bought 1.6544 DM.
Please note another fact that is important to know when dealing with European banks and/or European statistics. The table uses commas (,) instead of periods (.) as decimal points. In Europe, comas and periods are reversed. For example $121,000.50 would read $121.000,50.
Notice in the table which follows that over the years the DM has appreciated in value against every currency except the yen. In 1975 for example, 100 yen bought 0.8301 DM. In 1993, 100 yen bought 1.4945 DM. The DM has been appreciating against the Swiss franc (labelled Schweiz at the top of the column) over the last 10 years. Note that 100 SFR bought 120.016 DM in 1985. By 1993, 100 SFR bought only 111.949 DM.
The U.S. dollar, of course, has continually fallen against the DM. In 1986, one dollar bought 2.1798 DM. By 1993, a dollar bought DM1.6544 and as of this writing that dollar Dmark rate had fallen as low as 1.36.
We can see that the Dmark has been strong versus almost all currencies, but now in the case study below we will examine the underlying fundamentals and look at the future potential of the DMark.
In this study we will review the fundamentals of the German mark to enhance our understanding of this currency and to better learn the process we use to review the potential of any currency.
As discussed in earlier lessons, exports create demand which adds to a currency's strength. Last lesson we saw that Germany exports nearly as many goods (in US$ terms) as the United States, although Germany has only one-quarter the population of the United States. Below is a review of G7 exports.
1993 Exports U.S. $464 billion Germany $362 billion Japan $362 billion France $209 billion UK $180 billion Italy $168 billion Canada $145 billion
The solid record of German productivity, along with its exports and positive trade balance (discussed below) assure that German productivity is among the highest and most consistent in the world. This bodes well for the DM in the long run.
Japan, Germany and (to a lesser degree) Canada are the only G-7 nations with a positive trade balance (current account) over the last six years. This gives another indication of strength to the future DMark. Germany's trade balances for past years is below:
Germany U.S. 1987 65.928 billion -170.320 billion 1988 72.856 billion -137.115 billion 1989 71.529 billion -129.110 billion 1990 63.951 billion -123.395 billion 1991 12.935 billion -86.633 billion 1992 19.830 billion -105.760 billion 1993 35.083 billion -138.665 billion 1994 40.200 billion -154.500 billion
The interest rate of the German mark will vary, but we must take it into account every time we review the currency. Listed below is a comparison of past interest rate differentials between the dollar, yen and Dmark over the past 15 years.
With the unification process now well underway (started in 1990), the Bundesbank has been bringing down the discount rate. We know from previous lessons that a lowering of the interest rate will ultimately have a slight weakening of the DM on foreign exchange markets.
Year Germany U.S. 1980 7.50% 13.00% 1981 7.50% 12.00% 1982 5.00% 8.50% 1983 4.00% 8.50% 1984 4.50% 8.00% 1985 4.00% 7.50% 1986 3.50% 5.50% 1987 2.50% 6.00% 1988 3.50% 6.50% 1989 6.00% 7.00% 1990 6.00% 6.50% 1991 8.00% 3.50% 1992 8.25% 3.00% 1993 5.75% 3.00% 1994 4.50% 6.00+%
Germany has a very low debt to Gross Domestic Product ratio -- among the lowest of industrial countries. This indicates strength to the currency because there is less debt and thus interest to pay, which if held by foreign investors could cause a weakness in the currency.
Belgium 134.4% Italy 108.4% Canada 82.3% Netherlands 78.3% Japan 64.9% USA 63.0% France 50.1% Germany 44.0% UK 41.9% Switzerland 30.0% Australia 29.7%
A nation's debt takes on a different perspective based on the nation's tax collections as a percentage of Gross Domestic Product. For instance, in 1990 the U.S. collected in taxes 30% of the 1990 GDP. Japan collected 30% of its GDP, Germany 37%, and Belgium 44%. This means that it would be slightly harder for Germany to raise taxes (to reduce debt or avoid further debt) than the U.S. or Japan.
Belgium 44% France 43% Germany 37% UK 35% Canada 34% Switz. 31% Japan 30% U.S. 30% Australia 30%
There are several interesting ways to look at the contrast in the last two tables. First, if a country has a high debt/GDP ratio, such as Belgium (134.4%), it needs to collect a lot of tax to cover the debt. Belgium, however, is collecting a relatively high percentage of its GDP already, and will have difficulty raising taxes to chop away seriously at its outstanding debt. The ratio of debt/GDP over tax percentage for Belgium is 134.4%/44% = 3.05.
Germany's debt/GDP ratio is only 44%. Since it collects 37% of its GDP in taxes each year, the tax to debt ratio is 44%/37 = 1.19. Therefore, Germany will not have to raise taxes as much as Belgium to cover its debt. This clearly bodes well for the DM.
Japan in 1990 collected 30% of its GDP in taxes, therefore its tax to debt ratio is 31%/30% = 1.033. This excellent ratio indicates one of two things. Either the tax rate in Japan is exceptionally high, which it isn't relative to other countries, or the debt is low when compared with taxable income. This bodes exceptionally well for the yen.
The U.S. also collects 30% of its GDP in taxes. The U.S. tax to debt ratio is therefore 63%/30% = 2.1. This indicates that the U.S. will have somewhat more trouble raising taxes enough to cover its debt.
One of the stronger tax to debt ratio is Switzerland (30%/30% = 1.00). Strongest of all is Australia (29.7%/30% = 0.99).
Canada collects 34% of its GDP in taxes. Tax to debt ratio is 82.3%/34% = 2.42. The U.K. collects 35% of its GDP in taxes, giving it a tax to debt ratio of 1.19. Canada and the U.K., however, bring a new dimension into this concept. Both currently have high rates of taxation relative to other industrial countries and to raise taxes to any great degree will be hard to do. This is particularly hard on Canada, with its high 2.42 tax to debt ratio. It will have trouble raising taxes enough to offset the accumulating debt.
We can see from the case study above that the German mark is likely to remain strong in the medium term. However, what about the future? Germany has now rebuilt its economy from disaster at the end of WWII. Now it has a mature economy with very high labor costs and a work force that wants more and more and more time off and less and less work.
What we can learn most from the case study above is the process we must use continually of examining every aspect of a currency to determine whether the fundamentals and short term factors have shifted and whether the potential for the currency's strength has changed.
From our review we can see why the German mark is a currency which most investors should hold most of the time. Listed below are three top performing Dmark money market mutual funds, three Dmark bond funds and three funds that invest in German shares.
DIT Lux Cash DM A, Dresdnerbank Asset Mgt, 26 Avenue Marche aux Herbes, L-1728 Luxembourg. Tel: 011-352-47601. Fax: 011-352-476-0331.
Lloyds Intl Liquidity DEM, PO Box 136, Sarnia House, Le Truchot, St. Peter Port, Guernsey, Channel Islands. Britain. Tel: 011-44-1481-724983. Fax: 011-44-1481-727344.
HCM DM Cash Plus, c/o Hypo Bank, 4 rue Alphonse Weircker, L-2721 Luxembourg-Kirschberg. Tel: 011-352-42721. Fax: 011-352-4272-4500.
Mercury ST DEM Global Bonds, Forum House, St. Helier, Jersey, Channel Islands, Britain. Tel: 011-44-1534-600600.
Parvest Obli DEM, Banque Paribas, 10a Boulevard Royal, L-2093 Luxembourg Tel: 011-352-46461. Fax: 011-352-4646141.
CMI GNF German Bond, Clerical Medical House, Victoria Road, Douglas, Isle of Man, Britain. Tel: 011-44-1624-625599. Fax: 011-44-1624-677020.
CB German Index Fund, 10a Boulevard Royal, Luxembourg. Tel: 011-352-46461. Fax: 011-352-46464144.
CU German Growth Fund, Center Mercure, 41 Avenue de la Gare, L-1611 Luxembourg. Tel: 011-352-489061. Fax: 011-352-492369.
Fidelity Funds Germany, 3/F Kansalis House, Place de L' Etoile, L-1021 Luxembourg. Tel: 011-352-250-4041. Fax: 011-352-250-340.
Now that we have looked at the history of the German mark, let's turn our attention to the other currency powerhouse, the Japanese yen.
In 1945, Japan's major cities were in ruins and all foreign assets had been seized. But the country still possessed some industrial infrastructure. One major thing that Japan did have which proved to be its greatest long-term asset was an exceptionally well-educated and socially-cohesive population.
Money began pouring in from America after the war through the Reconstruction Finance Bank. Inflation took off as dollars washed through the country's growing economy, and by 1949 prices were 13 times higher than in 1945. Japanese industry was saved, in part, by "special procurement" orders from the United States. For example, Toyota, which was on the verge of bankruptcy, was given large orders from the U.S. Navy for trucks.
The Japanese Government took full control of the country in 1952. By then the economy had stabilized to a great degree. The Japanese government produced a balanced budget each year from 1952 to 1965. Taxation was held down, and government spending was held under 25% of the GDP (in contrast to over 40% for most other industrialized countries at the time). In particular, expenditures on welfare were low, and defense expenditure almost nonexistent. High rates of saving were encouraged, and consumption was discouraged. In fact, tax breaks favored savers and penalized consumers.
To this day Japan has one of the highest saving rates of any major industrialized country, exceeded only by Italy. The chart next page shows saving rates of the G-7 countries year-by-year since 1971.
The percentage on the left column translates: Savings divided by Disposable Income. This percentage indicates how much is actually saved in proportion to the total amount of income that citizens have to spend.
Notice in the chart that Japan's current rate of saving (indicated by the solid black line) is about 15%. The United Kingdom now has the lowest rate of saving, less than 5%. Canada and the U.S. are the other two countries with the lowest savings rate. The savings rate has a tremendous long-term impact on the value of a currency because it gives banks a rock-steady foundation for money-supply increases (if the money saved is invested in the country-hence Italy's high savings rate but very weak currency). The high Japanese rate of saving indicates that the yen may be much stronger than the dollar long-term.
The high savings rate during Japan's developing decades also led to major investment in fixed capital investments such as industrial plants and technology. The educational system became perhaps the finest in the world, and the infrastructure developed with incredible speed and efficiency.
Between 1950 and 1973, Japan's GDP grew at an incredible 10.5% a year, compared to a rate of about 5%-6% for other major industrialized countries. Even after the 1973-4 oil crisis, Japan's GDP continued to grow at about twice the rate of other major countries, and Japan soon moved into major markets around the world. Japan overtook the Swiss watch industry, nearly wiped out the German camera industry, and practically destroyed U.S. TV manufacturers. Immediately after the war, Japan shifted from its centuries-old focus on textiles (a rudimentary product relying on cheap labor). In 1936, textiles accounted for 52% of all Japanese exports. By 1978, that had fallen to less than 5%. Engineering goods took their place -- including transistor radios, clocks, scientific instruments, computers, semiconductors, and, of course, automobiles. Between 1960 and 1985, Japan took nearly 25% of the world's auto market. Today Japan's U.S. share is over 30%.
In his 1970 book, The Emerging Japanese Superstate (Prentice Hall), Herman Kahn wrote:
"The situation in Japan is very different from that in the United States. Probably more than 50 per cent of all Japanese government officials devote their time to improving prospects of business. However, one would conjecture that in the United States more than 50 per cent of all government officials devote their time to almost the opposite task -- many of them to sponsoring groups with grudges against the business system and the establishment, or groups that are anti-business, anti- economic growth, anti-capitalist, and even anti-rationalist, at least from the economic standpoint."
Government in Japan spends much of its resources helping businesses expand exports, build facilities, and operate in close harmony with banks. As will be shown in a moment, this support of business can keep exports and growth strong even during difficult times.
The previous lesson discussed Germany's concept of Universal Banking, in which banks are permitted to own shares in companies and other banks, a luxury not permitted U.S. banks.
This concept is practiced with even greater tenacity in Japan. A keiretsu is the Japanese version of a combination of private business and banks linked by cross-holdings of common stock. Bank keiretsu is practiced in many countries to a lesser or greater degree, but they have one thing in common, all members of the group receive long-term financial support from a bank. This concept is vividly described in the excellent book, The Banking Keiretsu, by Hazel J. Johnson (Probus 1993).
"The Japanese keiretsu is a business combination involving interlocking ownership of financial and industrial firms, with a bank acting as one of the dominant firms in the group. A keiretsu bank not only provides loans to the members of the group, but holds ownership shares in them as well."
One of the largest keiretsu is Mitsubishi, with ownership in part as listed below:
Company % of firm owned by keiretsu members Mitsubishi Corporation 32% Mitsubishi Bank 26% Mitsubishi Heavy Industries 20% Mitsubishi Trust and Banking 28% Tokio Marine & Fire Insurance 24% Mitsubishi Motors 55% Nikon Corporation 27% Kirin Brewery 19% Mitsubishi Oil 41% Mitsubishi Electric 17% Mitsubishi Plastics 57% Mitsubishi Petrochemical 37% Mitsubishi Gas Chemical 24% Mitsubishi Metal 21% Mitsubishi Aluminum 100% Mitsubishi Steel Manufacturing 38% Asahi Glass 28% Mitsubishi Construction 100% Mitsubishi Cable Industries 48% Mitsubishi Paper Mills 32% Mitsubishi Rayon 26% Mitsubishi Mining & Cement 37% Mitsubishi Estate 25% Mitsubishi Warehouse & Transportation 40%
The list goes on, but I'm by now sure you get the picture. Every member firm benefits from the relationship. When one of the firms gets into tough going, finances are temporarily diverted from another. All firms, of course, are supported by the bank. Such arrangements are entirely illegal in the United States. Not since the days of J.P. Morgan's trust companies that owned or controlled banking, transportation and industrial facilities has the U.S. allowed banks to be engaged in such practices. The 1933 Glass-Steagall Act outlawed commercial bank ownership of industrial companies.
Several of the other major Japanese keiretsu, with names of their chief companies:
Keiretsu Industrial Members Mitsui Toshiba, Toyota Motor Co. Sumitomo NEC Corp. Fuyo Nissan Motor Co., Canon, Hitachi Dai-Ichi Kangyo Fujitsu, Isuzu, Hitachi Sanwa Sharp, Daihatsu Motor Co.
Mitsubishi Keiretsu today owns over 160 companies, Mitsui over 120, Fuyo over 150, Dai-Ichi Kangyo over 90, and Sumitomo over 130. Each keiretsu has a central banking operation and other financial firms, often life insurance and commercial business insurance companies. To give you an example of the degree of concentrated power in these groups, the 40 or so largest Mitsubishi companies alone produce more than 7% of Japan's annual GNP.
To understand the heart of Japanese business, one must understand the origins of the keiretsu concept.
In the mid-1800s, United States and European business moved rapidly into Japan. The country was deeply humiliated by this easily- accomplished invasion, and acted to strengthen the fabric of Japanese society. It was widely believed in the country that the citizens must abandon its focus on Confucian and Zen, and expand its vision to the science of the West. In 1881 the government selected several hundred students to study in the West. Over half were sent to the United States, and they brought back with them the germ of the Japanese educational system. Before that time, education had not been compulsory, and higher education was reserved for the chosen few.
In addition, the government organized isolated private companies into larger industrial organizations. Soon there were government railroads, steel mills, shipbuilding facilities, etc. But these were not always efficiently run, so they were sold to the largest merchant families of the time. Mitsui, Mitsubishi, Sumitomo, and Yasuda were but a few of the largest. The new industrial families used the educational reforms and massive government investment to form businesses based on educated, skilled and low-cost workers and well-capitalized production facilities. The large zaibatsu (as the merchant families were called), developed into major holding companies that pursued both internal and international growth.
The government became increasingly militaristic, annexing Korea and Manchuria. This led to the start of WWII, with the eventual defeat of Japan. After the war, U.S. occupation forces promoted the democratization of business by breaking up the zaibatsu and prohibiting banks from owning more than 5% of the stock of any industrial company. But the Japanese crave intermingling, and no amount of regulation could snap the cultural loyalty the Japanese had for the cross-connecting of government, business and banking.
The 5% limitation-law led to tremendous corporate inbreeding. One company, as an example, may have bought the allowed 5% in another company, which bought 5% in another company, which bought 5% of yet another company as well as 5% in each of the first two companies, etc. etc. In 1953, soon after the U.S. occupation ended, the 5% limitation was increased to 10%. This spurred tremendous inter-concentration of investment, with a cumulative effect in which as much as 70% of the stock of a company was often held by keiretsu members.
This keiretsu arrangement allows companies to focus on long-term rather than on short-term growth. Individual shareholders and corporate owners (which are, essentially, the banks and other members of the keiretsu) are more interested in perpetuation of the group than in jumping through hoops to present attractive quarterly statements. Such hoop-jumping is the bane of U.S. business. It essentially prohibits long-term research and development, which ties up capital for indeterminate future payoff (an arrangement that profit hungry and time conscious U.S. investors avoid like the plague).
U.S. banks are not permitted to own shares in outside firms, including industrial companies and financial facilities. Imagine executives of Chase Manhattan sitting at a table to discuss pricing matters with executives of Metropolitan Life Insurance Company and Merrill Lynch. Now imagine that each of these companies owns or controls each of the others, with perhaps GM, U.S. Steel, IBM, and dozens of other large U.S.- based multinational companies also in on the arrangement. This would just about give an equivalent of some of the largest Japanese keiretsu.
In Germany, the keiretsu is dominated by the universal banks, which own stock in a network of companies that are, in effect, owned and directed by the banks. This situation is described in the previous lesson.
In China, The People's Bank of China works closely with the government to coordinate activities of the Industrial and Commercial Bank of China, which has a nationwide network of over 20,000 bank locations and works as the intermediary between government (with its innumerable dictates) and individual businesses.
The Korean equivalent of the keiretsu is called a "chaebol", in which major industrial corporations hold shares in a number of different banks. This strong central network has enabled Korea to become a major player in steel, electronics, and textiles.
In the U.K., the banking keiretsu consists of the large commercial banks: Barclays, Lloyds, Midland, and National Westminster. Recent government relaxation of bank laws and privatization of major industries has allowed tremendous growth in the U.K. along the keiretsu line.
In the years after WWII, the U.S. dollar was the world's strongest currency -- resulting in low U.S. exports and high imports. (When the dollar is strong vs. other currencies, U.S. goods cost more overseas, making U.S. exports relatively more expensive and imports relatively less expensive.) Throughout the 70s and early 80s, with the yen cheap in comparison to the dollar, Japan's sales of goods to the U.S. accelerated, resulting in a massive trade deficit for the U.S. and a massive trade surplus for Japan. During the early 1980s, the U.S. deficit with Japan alone averaged $50 billion a year.
The 1985 Plaza Accord (involving the U.S., the U.K., Germany, Japan, and France) set agreements to help lower the value of the dollar. Each of these countries agreed to intervene on international markets to correct the dollar's overvaluation. Japan agreed, although the country by its nature usually enters into such agreements reluctantly.
As the dollar weakened, the yen became more valuable. Japan began to experience what is called "endaka", a period of a strong yen. At the time of the Plaza Accord in 1985, the yen was 260 to the dollar. Within three years after the Accord, the yen was 120 to the dollar.
Now comes the interesting part, showing how Japanese business (keiretsu organizations) and government ministries joined forces to keep exports flowing even during a time of increasingly expensive yen. Normally, a strong currency results in decreasing exports as goods became more expensive overseas, but this did not happen as the yen grew in strength. Government experts in the U.S. waited, believing that the strengthening yen would lead to a reversal of the U.S. trade deficit with Japan. U.S. automakers waited, and even raised their prices, thinking that Japanese imports would go up in price.
But they never did. In fact, some Japanese automakers actually reduced prices in the U.S. at this time, working desperately to maintain market share until they could set up production facilities within the U.S. (to get operations into the price structure of the dollar).
For example, when there were 260 to the dollar, a $5,000 profit on a Japanese-made automobile sold in the U.S. resulted in a profit of 260 x 5,000 = 1.3 million. But when there are 120 to the dollar, the same $5,000 profit is only 120 x 5,000 = 0.6 million. The U.S. government and U.S. businesses expected Japanese manufacturers to raise their prices to cover these thinner profit margins. Instead, the keiretsu banks provided financing to help make up the difference in profits resulting from the more expensive yen, with the Bank of Japan often providing the balance. This is the classic example of how the Japanese (and to a somewhat lesser extent the German) banking/business system looks more to the long-term than the short-term. No U.S. business could have afforded to take this long-term view. Shareholders would have bailed out after the first quarterly loss. Not so in Japan.
In addition, the Japanese government stepped in at this time to help restructure industries hit hard by the expensive yen. The Finance Ministry and the Bank of Japan worked to keep interest rates low. Land values shot skyward as real estate activity boomed, allowing corporations to borrow against these high (some would say extremely artificial) real estate values. This cheap money and easy borrowing gave additional cash to companies during this period. Along with this, the Japanese stock market skyrocketed, reaching all time highs in the late 80s.
To make matters worse for long-term U.S. competitiveness, from 1986 to 1991 Japanese companies invested more than $3 trillion in new plants and manufacturing processes. This served to make production more efficient, cheaper...and just plain better. At the same time, backed by the keiretsu banks, Japanese companies began investing heavily in the U.S., buying plants and setting up manufacturing operations using the cheap dollar and the "cheap" labor force of the United States. This is how Japan survived and prospered during the times of the expensive yen. But even the Japanese economy is not totally invincible, as we will learn when we continue our review of the yen next lesson.
Velocity. The velocity of a currency measures how rapidly the currency is strengthening or weakening. This helps us measure future tendencies of strength or weakness. The velocity of a currency is measured by dividing the currency's latest value (compared to the dollar) by the 9- month average of the currency's value against the dollar. For instance, if the 9-month average of the yen is 97.00 (meaning that one dollar buys 97 yen), and the latest value of the yen is 101, the velocity is figured by dividing 101 by 97 (101/97=1.041). Since the yen, at 101, is higher than it had been on average during the past 9 months, the value of the yen is tending to rise, and therefore is a good bet to rise further. Velocities over 1.00 of any currency indicate that the currency may be a good buy. Velocities less than 1.00 indicate that a currency is falling in value and may be a good candidate to sell.
Bretton Woods. The international meeting near the end of WWII, in 1944 at Bretton Woods, New Hampshire, where 44 nations carved out an agreement stabilizing world trade and pegging the price of gold to the United States dollar ($35.00 = 1 oz. gold). Also created at the meeting were the World Bank, whose role was designated as assisting developing countries (mostly Eastern European countries) and the International Monetary Fund (IMF), whose role was to maintain stable exchange rates between countries. The Bretton Woods system, as it is now called, collapsed in 1971 when the United States removed the dollar from the gold peg, allowing the dollar and all currencies to "float" against each other. Gold immediately jumped in price, since its value had been artificially suppressed by being pegged to the dollar. The value of the dollar began to decline at this point, because it was no longer tied to the stability of a precious metal. Part of the Bretton Woods Agreement was a plan to rebuild the economies of Japan and Germany.