Safe Haven Currency

by Stephan Smith on February 2, 2012

A safe haven currency is a currency investors denominate their assets in, for the purpose of protecting their investments from uncertainties due to elevated economic, financial, political or natural risks. There are many factors that can have a negative affect on the value of one’s assets. Individuals and organizations who are savvy and are able to identify those factors and the levels of risk those factors expose one’s assets to, can make a sound decision on whether or not to keep assets denominated in the original currency or move them to a safe haven currency.

But what are those factors and risks? What are the those scenarios that can negatively affect one’s asset valuation and prompt the transference of one’s assets from the original currency to a safe haven currency. If you continue reading below, you will see that I have answered those questions and more.

Hopefully at the end of this article, you will have a solid understanding of the factors, risks and scenarios that would prompt investors to move assets to a safe haven currency. You will also learn what makes safe haven currencies safe and you will be able to identify the risks associated with safe haven currencies [yes, there are risks]. It’s a lot, but it isn’t too difficult to understand.

Swiss franc

The Swiss franc, the currency you see above, is commonly known as a 'Safe Haven Currency''.

It’s All About The Currency

The primary reason an investor would want to transfer one’s assets into a safe haven currency is typically because that investor forecasts currency valuation changes that would negatively affect one’s asset value. It’s all about the currency. If you’re an expert in bonds and all you know is how to generate significant profits from bonds and a negative fundamental economic development like hyperinflation becomes a reality, then you as a bond investor will be in major trouble. You wouldn’t be able to generate a return high enough to counteract the hyper-inflationary pressures, and because of that, in the end you will lose money.

In that instance it would make sense for you to consider transferring your assets into a safe haven currency so that you wouldn’t be negatively affected by the hyperinflation affects. That’s just one example. But I really want to get this point across… it’s all about the currency. When the outlook of a currency’s valuation is looking negative relative to how it affects an investor’s asset value, then it would make sense for that investor to consider moving investments to a safe haven currency.

Things to Look Out For

Remember, most investors would consider moving assets to a safe haven currency only if the original currency is believed to change in valuation in such a way that it would negatively affect the investor’s asset value. But what does an investor look for in order to accurately forecast such events. Every individual and organization swears by their own indicators, but here are some very popular ones I look at.

Japanese yen

The Japanese yen, the currency you see above, is commonly known as a 'Safe Haven Currency''.

Monetary Policy

First things first. If you want to make sure the currency your assets are denominated in doesn’t negatively affect your investments, then you must be aware of the monetary policies set by your country’s central bank. In this world system, the central bank holds the keys of currency valuation.

You are going to need to familiarize yourself with contractionary monetary policies and expansionary monetary polices in order to get some idea as to where currency trading prices are headed. By being an expert on the various polices central bankers implement, as well as being able perform other fundamental analyses, you will gain rather accurate foresight of currency pair valuations.

Fundamental Economic Statistics

Another factor that can influence an investor to transfer one’s assets to a safe haven currency are various fundamental economic developments and statistics. Developments and statistics like inflation or deflation, economic contraction which is represented via a negative gross domestic product, high levels of unemployment, high levels of international trade balance deficits, extreme capital outflows with contracted capital inflows and more.

All of these economic indicators and even some I haven’t listed can play a pivotal role in influencing the decision on whether or not to seek safety in a safe haven currency. I won’t go into detail as to what each economic indicator means, but I want you to be aware of the ones that count. But why do they count? They count because economic indicators like to ones I’ve listed influence central bankers when they conjure up monetary policy. Monetary policy influences currency valuation; economic indicators influences monetary policy.

Political & Natural Risks

There also some factors that can influence economic indicators. Those factors are political developments and natural developments. If a country’s government is unstable or doesn’t provide an environment that is complementary to economic growth, then that government will negatively affect the country’s economic indicators which then would influence central bankers to implement expansionary monetary policies.

Such a scenario would prompt investors to move to safe haven currencies. The same would apply to natural developments. If a country is hit with a devastating natural disaster, such as an earthquake, volcano eruption or something else, and the damage significantly disrupts economic activity, that would have a major affect on the country’s economic indicators, which again would influence central bankers to implement expansionary monetary policies. Since expansionary monetary policies weaken a currency relative to other currencies and commodities, investors would feel pressure to move to safe haven currencies.

What makes a Safe Haven Currency Safe?

Ok, you should now have an understanding as to what safe haven currencies are and an understanding as to what risks prompt individuals and organizations to shift their assets to them. Two currencies that have acquired the title ‘safe haven currency’ by investors worldwide is the Japanese yen and the Swiss franc. But are you wondering what makes a safe haven currency safe? What makes the Japanese yen safe? What makes the Swiss franc safe? It’s a good question. What about them makes them safer than any other currency?

Here’s the answer. Demand. That’s it. Demand for the currency is what makes them safe havens. As I mentioned before, the Japanese yen is considered a safe haven currency by millions of people around the world. But why? It has nothing to do with the monetary policy set by the Bank of Japan; for the Bank of Japan has been maintaining some of the most expansionary monetary policies this green Earth has even seen.

It has to do with simple demand for the currency. Everyone and their mother wants Japanese yen, even if they know it or not. Japan has a major export based economy. The world loves Japanese goods and services and the world is buying it up like there’s no tomorrow. But there is a problem. You can’t buy Japanese goods and services without first buying Japanese yen. And it is in that fact where elevated demand for Japanese yen stems from. The same applies for Swiss francs.

So what makes a good safe haven currency? Currencies that are home to countries with major international trade surpluses. Why? Because international trade surpluses is an indicator of strong global demand for the country’s goods and services and thus the currency.

Risks Associated with Safe Haven Currencies

I do want to make you aware that safe haven currencies aren’t 100% safe. There are some risks to holding them; and those risks aren’t completely alien from the risks any other currency may experience. If negative monetary polices, economic statistics, political or natural developments occur and it is significant enough to overtake the demand of safe haven currency, then it is possible for that safe haven currency to lose its safe haven title.

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