Interlude : The special currency convexity of a portfolio of social pensions, when you need it most...

In this episode, we are going to take a break from the construction, and features, of a portfolio of social pensions, and talk specifically about the unique tax and value convexity of having a portfolio of regular payments in different currencies in retirement, in combination with other assets of course.

We are going to keep things fairly simple to illustrate the value strategy.  Let us assume that our merry frolickers have managed to acquire 4 social pensions over the course of an astute working life, spent frolicking globally, and that our astute fellows have collected 3 major reserves and 1 semi reserve.  I do not care which of usd, gbp, jpy, eur you collect as majors; or which of aud, nzd, cad you collect as a semi-reserve.  The general strategy relies on the relative volatility amongst a basket of reserve currencies over a multi-year period, and the macro cyclical rotation that occurs between reserve and semi-reserve currency blocks.  You only need to look at a long term history of exchange rates and mark periods of extreme financial or economic stress in the majors and roaring commodity markets in the semi-reserves to see these strong rotations that occur time and again.  The recipe to risk management of a currency crisis in your domestic currency, whilst taking advantage of shocks in the production opportunity frontier in other countries is holding a negatively correlated mix of currency incomes folks.  It is not rocket science.

Let us assume you spend down your 3 most currently valuable currencies, those higher than mid-cycle valuations against the 4th, and save the 4th.  If you have a shortfall make it up out of assets in one of the 3.  Often the weakest will be the semi-reserve.  It is how global growth and stage of development works.  That simple.  Over years the relative values will bounce around within a block.  For example look at gbp/usd over the last 30 years and this minor convexity will work for you as long as have selected a base location well.  More on that when we get onto frolicking...  However, periodically a strong rotation will occur.  The currency mix will change by 30-40% relatively quickly between the major and semi-reserve blocks, and your savings in the weakest currency will suddenly be worth 40% more tax-free, since there is no tax to pay on your existing cash capital.

Currencies are at their most volatile when inflation rates are diverging globally since inflation spreads then diverge, and when real interest rates have been shocked out of long-run equlibria.  The third aspect is country risk premia.  This could be a financial shock like the gfc, or a war in the ukraine, or a natural disaster, or a technological innovation that pushes capital demand to one country strongly.   These are jsut examples...  The point is that your pension can easily become a moderate global macro bet with only upside produced periodically.  That is value convexity in action.  You simply sit back and take notice of a few long history fx charts and pick your timings.

This is one of the best reasons to not be totally dependant on social pensions in retirement.  You want to have other assets to draw on when you see an optionality argument like this, particularly when it expresses both value and tax convexity like this macro trade does.  Never forget that for a guy paying a 30% marginal tax rate, not being liable for tax is a 50% increase in take-home spending power.

To give a simple example, after the gfc the usd rotated from about 1.7aud to about 0.9aud at its trough.  Had you been saving your aud pension adroitly for 10 years prior, you would have saved value of about 330k usd instead of about 170k usd.  That is 160k usd of additional value in your wealth base, because you were adroit enough to spend out of strong currencies and wait for the global macro cycle to do what it does - change.  It is completely tax free.  It is money sitting in your bank account, sourced in the local currency. that has a different relative value in another currency than it used to.  There is no trading involved in brokerage accounts.  The tax man can go whistle, and he knows that.  Please learn today that a global life, with judicious choice of location at different times, and a healthy but moderate asset and income base, can produce lovely occasional positive shocks to your value, tax free.  The key investment strategy is knowing it, and patience...

For those of you who choose to join my newsletter i will be providing some analytic examples of this trained on real foreign exchange historic data.  At a later time, i may even offer you all a little AI predictive engine to help call the timings with some machine optimality and show you how currencies relate to each other right now compared to long-term parity and recent cyclical ranges.  

Yes, your financial frolicker is a serious quantitative developer off exotic options desks in big investment banks (including fx desks) with a bit of genuine down-to-earth hard-studied know-how.  No readers, you did not miss my copywriting...  I have not mentioned my newsletter service yet, because i am here to help you make better long-game decisions, not sell you stuff for the sake of it.  I abhor the hard sell of glib publicly available knowledge that the online business community is self-fascinated by, and which mostly amounts to a load of incitement to try something pretty risky, and hoping for the best.  Is anybody thinking of flipping real estate as interest rates surge from 0 to 7% after the biggest ponzi bubble in housing in history?  You bet they are selling that game like crazy on youtube.  The real sell is finding somebody naiive enough to listen of course.  It's utterly shameful and it makes capitalism is farce in low ethics.