Currency Architecture: Aligning Global Wealth with Real-World Spending
Compardo, Wienstroer & Janes at Moneta
When our lives take on a global dimension, they often become more complex. Building assets and incurring liabilities overseas often entails an additional layer of complexity – currency risk. Whether it is buying an apartment overseas or committing to a steady stream of expenditure, such as college fees, currency fluctuations can lead to windfalls or sticker shock according to the direction of travel.
Currently, the US dollar remains strong in relative terms, which will increase purchasing power outside the US while diminishing the value of non-US remittances, earnings, or gifts. When planning a purchase, there may be a desire to “get ahead” of an adverse US$ currency movement; when paying, say, college fees, there may be a desire to lock in the amount of an obligation.
At Moneta, we think about this through the lens of currency architecture.
We think about global life as having different pillars, with each pillar representing the cash flow in a particular currency. If life spans the US and Europe, then these two pillars would be US$ and Euro.
In practical terms, every major future obligation can be examined through three questions: In what currency will it arise? Are there any earnings in that currency (e.g. rental income or dividends) which can offset these obligations? When will the money be needed and what do I need to do to ensure I have enough money to meet these obligations?
Thinking about inflation, interest rates, exchange rates and investment opportunities
Once those building blocks are identified, the next question becomes more nuanced: what are the different economic dynamics affecting these currencies or markets.
This is where inflation, interest rates, taxes and investment opportunities enter the conversation.
The currency zone experiencing higher inflation presents a different set of considerations from one where prices are relatively stable. There may be a need to keep a closer eye on expenses in this region while interest rates may well be higher there as a reaction to higher inflation. Higher interest rates may make saving in that currency more attractive, but inflation will erode the currency’s purchasing power. Interest rates may also affect the exchange rate that that currency has with the home currency (presumed here to be the US$). Exchange rates are notoriously volatile and hard to predict, and we generally do not recommend that investors conduct currency hedging as usually the movements due to exchange rates have a neutral effect over time.
Interest rates may also dictate how attractive it is to borrow in a currency e.g. to obtain a mortgage (which is itself sometimes a complex undertaking depending on the jurisdiction), while awareness of inflation may dictate the expectations around salary increases in that currency (where relevant), expected appreciation of an asset (e.g. real estate) as well as general economic stability that will enable planning in a region.
Where a particular purchase is planned, and it is a large one (e.g. an apartment in London), it might be desirable to lock in an exchange rate between the price being agreed and the actual closing. This can make the amount in US$ certain and not subject to change – positively or negatively. Interest rates, inflation and return drivers will all affect the investment return in a region, and thinking about investments in a foreign currency is also essential when it comes to understanding the additional bonus return (or drag) that currency fluctuations can create.
Common Questions
What is currency architecture? Currency architecture is a framework for thinking about currency exposure as a collection of building blocks tied to actual spending needs across countries, rather than treating the entire financial picture as a single home-currency portfolio.
Is currency architecture the same as currency hedging? No. Hedging generally focuses on managing the impact of currency movements, often over shorter periods. Currency architecture is a longer-term planning framework that considers where spending needs are likely to arise and how to position for those needs over time.
How do inflation and interest rates factor into currency architecture? Different currency zones have different inflation and interest-rate environments. Those differences can influence both the return required to maintain spending power and where it may make sense to hold or save a particular currency.
Should I react when a currency moves sharply? Generally, we recommend against knee-jerk reactions or large transactions made in response to short-term currency movements. A steadier approach, in which exposure is considered and averaged over time, can be better aligned with long-term financial needs.
Who needs to think about currency architecture? Anyone with meaningful spending, family or property commitments in more than one currency may benefit from considering it. That could include a child attending school abroad, a second home in another country, or income earned in one currency while future spending is expected to occur in another.
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