Cash is always king in a financial meltdown

Posted on 14 October 2009 with no comments from readers

Holders of UAE dirhams have watched the value of their currency whittled away this year alongside the US dollar to which the dirham has a fixed peg. But saving cash on deposit is a very useful hedge for risk against another financial meltdown.

Yesterday I was out with a Citibank banker who told me he had just sold all his mutual funds after holding them for eight years. He had got back almost exactly what he had put in. In fact, his money would have been better in a deposit account. Of course, allowing for inflation and devaluation his money was actually worth less than eight years ago.

Stock market crash

But imagine how he will feel if the stock market tanks over the next few days. Indeed, it may well do so. Stock markets have rallied hard since March and yet global economic conditions have not improved by that much, and a correction looks unavoidable.

You could perhaps choose gold as an alternative to cash. But last year in the financial crash gold also lost value very quickly because of the need by some players for cash to meet margin calls on their stock market portfolios.

In truth, all asset classes took a hit at the same time. Commodities like oil and even silver plummeted. And what did you require to take advantage of that situation? Why cash of course!

Also dirham holders might care to think in a contrary fashion. With 98 per cent of currency traders negative on the dollar that ought to mean that all the bad news is in the price, or exchange rate in this case.

Dirham holders do not even have to put up with the poor interest rates on dollar deposits. There is 3.5 per cent on four-month time deposits in dirhams at HSBC.

Investment risk

Now I am not saying that always holding dollars or dirhams on deposit is always going to be a marvelous investment. But it might be at this moment in time as asset depreciation means that dollars will soon buy more, and such deflation is all around us right now, except in the stock market.

The credit that drove inflation around the world is very tight right now with banks hoarding their capital and seeing little reason to take risks on lending. Without this new money chasing goods and services prices will drift lower. Keep your cash until tomorrow and it will buy more.

This is a very different investment scenario to the pre-crisis era, and hedging risk by holding some cash to buy assets at depressed prices later just sounds clear common sense.

But you should remember to do that. For on the horizon a bond crisis must be coming which will impact the dollar negatively. No major financial crisis has ever ended without one. The interest paid on cash is too low and will have to go up or people will not buy bonds, and when rates go up then bond prices go down.

Still at least those with cash will then get higher interest rates again and not be hit by falling bond prices. Cash looks a short-term winner.