Very high interest rate in other countries? How come?

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kayanco
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Very high interest rate in other countries? How come?

Post by kayanco » Wed Jul 16, 2014 12:08 pm

Hi guys,

Here in the US we currently have interest rates of only about 2% max. (e.g. 5-year CD)

I was looking at foreign interest rates on www.deposits.org, and I see countries with VERY high interest rates.

Examples:
India with 9% (india.deposits.org).
And someone from Pakistan told me the 5 year government certificate is at 12-14%.

Can someone please help me understand this vast dichotomy?

Does this mean folks who have accounts in these countries (e.g. dual citizens or temporary workers in US), and transfer their dollars, can make MUCH more in savings accounts and government bonds?

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Re: Very high interest rate in other countries? How come?

Post by Beliavsky » Wed Jul 16, 2014 12:15 pm

Inflation is one factor determining interest rates. You should look at real interest rates (nominal rate minus inflation) as well as nominal rates. Inflation data from the World Bank is at http://data.worldbank.org/indicator/NY.GDP.DEFL.KD.ZG . My reading of the academic research is that higher interest rate currencies tend to depreciate against lower rate ones, but by less than the interest rate differential. So it has been profitable to own higher rate currencies, but the profit has been less than the nominal rate spread.

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Re: Very high interest rate in other countries? How come?

Post by bs010101 » Wed Jul 16, 2014 12:19 pm

They can make more in rupees, but they likely won't make more in dollars due to interest rate parity, which states that inflation will reduce the value of the higher interest currency enough to even it out with the lower paying currency. Lots of factors drive interest rates, but in general return matches risk, so investors are demanding higher interest rates to invest in those currencies due to the risk inherent in the currency.

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Re: Very high interest rate in other countries? How come?

Post by Phineas J. Whoopee » Wed Jul 16, 2014 12:46 pm

Please consider it isn't so much different countries as it is different currencies. Your two examples are Indian rupees, INR (59 to a US dollar, USD), and Pakistani rupees, PKR (100 to a USD).

Everbank, based in the United States, offers foreign-denominated CDs, although not 5-year ones. They're offering an APY of 4.06% for 3 months in Indian rupees. They don't offer Pakistani rupee denominated accounts, but just for some examples: South African rand 4.32%; Norwegian krone 0.13%; and Japanese yen 0.00% (which means it's a pure exchange-rate play, or that you have a known upcoming liability priced in yen). All of those are offered by a US bank. It isn't per country, it's per currency.

So, if you normally work in US dollars, and you want some of that juicy Indian rupee interest, you'll need to convert dollars to rupees (which isn't free), buy the 3-month CD, wait for it to mature, and convert the rupees back into dollars (which not only isn't free, but probably will be at a different exchange rate than three months earlier).

Everbank says Indian inflation is running 6%, so you'd be falling behind by 1.9% annualized plus costs. With a 3-month USD CD from Beal Bank you could earn 0.51%, and with latest reported USD consumer inflation of 2.1% you'd lose out by 1.6%, with no currency conversion risk or cost.

PJW

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Re: Very high interest rate in other countries? How come?

Post by ralph124cf » Wed Jul 16, 2014 5:25 pm

Phineas J. Whoopee wrote:Please consider it isn't so much different countries as it is different currencies. Your two examples are Indian rupees, INR (59 to a US dollar, USD), and Pakistani rupees, PKR (100 to a USD).

Everbank, based in the United States, offers foreign-denominated CDs, although not 5-year ones. They're offering an APY of 4.06% for 3 months in Indian rupees. They don't offer Pakistani rupee denominated accounts, but just for some examples: South African rand 4.32%; Norwegian krone 0.13%; and Japanese yen 0.00% (which means it's a pure exchange-rate play, or that you have a known upcoming liability priced in yen). All of those are offered by a US bank. It isn't per country, it's per currency.

So, if you normally work in US dollars, and you want some of that juicy Indian rupee interest, you'll need to convert dollars to rupees (which isn't free), buy the 3-month CD, wait for it to mature, and convert the rupees back into dollars (which not only isn't free, but probably will be at a different exchange rate than three months earlier).

Everbank says Indian inflation is running 6%, so you'd be falling behind by 1.9% annualized plus costs. With a 3-month USD CD from Beal Bank you could earn 0.51%, and with latest reported USD consumer inflation of 2.1% you'd lose out by 1.6%, with no currency conversion risk or cost.

PJW
For these foreign currency denominated CDs, does FDIC insurance apply?

Ralph

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Re: Very high interest rate in other countries? How come?

Post by Phineas J. Whoopee » Wed Jul 16, 2014 5:43 pm

ralph124cf wrote:...
For these foreign currency denominated CDs, does FDIC insurance apply?

Ralph
Hi Ralph,

Please find the answer to your own question, I suggest starting with https://www.everbank.com/, and report back with the result.

PJW

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Re: Very high interest rate in other countries? How come?

Post by berntson » Wed Jul 16, 2014 6:04 pm

I can't remember which one it was, but one of the recent Credit Suisse yearbooks had an article showing that historically, the bonds of countries that have recently had high inflation tend to out perform those with recent low inflation (in real terms). So there is something to the idea of buying bonds from countries with high inflation and high rates.

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Re: Very high interest rate in other countries? How come?

Post by ashutosh » Wed Jul 16, 2014 6:10 pm

The reason for higher interest rates, is because inflation in the countries you mentioned are higher. Banks can pay 10% interest for CD, because it can give out car loan/mortgages at 14%.

Regarding whether this piece of information (i.e. higher interest rates in some countries) can be used to make money, as always, there is no free lunch. There are several risks involved, as some have already pointed out:
a) Currency exchange fees. You lose >2% to transfer USD to other currency and back (my brother lost 1.25% one way, i.e. 2.5% total when converting to INR and back).
b) Tax law change in foreign country. IRS of India does not tax such non residents deposits' interest. May change tomorrow.
c) Currency volatility: Plot Pakistan vs USD or INR vs USD. Its roller coaster all the way.

If you get 2% in US and 9% in India, the difference is 7%. Assuming federal+state tax of 35%, 8% reduces to 4.5%. Loss during currency exchange (which should be deducted from after tax returns) is 2.5%. This leaves 2.0% as MAXimum extra return you can hope to obtain. A currency devaluation of 10% (not so uncommon) would immediately wipe out 5 years of this extra return.

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Re: Very high interest rate in other countries? How come?

Post by Levett » Wed Jul 16, 2014 6:14 pm

PJW noted: "as it is different currencies"

Funny how even some public pundits keep overlooking this. :oops:

Lev

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Re: Very high interest rate in other countries? How come?

Post by TX_TURTLE » Wed Jul 16, 2014 8:18 pm

Beliavsky wrote:Inflation is one factor determining interest rates. You should look at real interest rates (nominal rate minus inflation) as well as nominal rates. Inflation data from the World Bank is at http://data.worldbank.org/indicator/NY.GDP.DEFL.KD.ZG . My reading of the academic research is that higher interest rate currencies tend to depreciate against lower rate ones, but by less than the interest rate differential. So it has been profitable to own higher rate currencies, but the profit has been less than the nominal rate spread.
What Beliavsky said. In addition, you need to consider the 'country risk'. For instance, one of the highest rates in the table is for Argentina. In 2002, after 10 years of maintaining their peso pegged one to one with the US dollar, Argentina suddenly devaluated. Within a few months you needed four pesos to buy one dollar. If you had an account in an Argentinean bank it was suddenly worth 1/4th of the original value. Eventually they defaulted and ended up restructuring their debt. Their creditors took a haircut.

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Wed Jul 16, 2014 8:38 pm

Beliavsky wrote:Inflation is one factor determining interest rates. You should look at real interest rates (nominal rate minus inflation) as well as nominal rates. Inflation data from the World Bank is at http://data.worldbank.org/indicator/NY.GDP.DEFL.KD.ZG . My reading of the academic research is that higher interest rate currencies tend to depreciate against lower rate ones, but by less than the interest rate differential. So it has been profitable to own higher rate currencies, but the profit has been less than the nominal rate spread.
bs010101 wrote:They can make more in rupees, but they likely won't make more in dollars due to interest rate parity, which states that inflation will reduce the value of the higher interest currency enough to even it out with the lower paying currency. Lots of factors drive interest rates, but in general return matches risk, so investors are demanding higher interest rates to invest in those currencies due to the risk inherent in the currency.
Phineas J. Whoopee wrote:Please consider it isn't so much different countries as it is different currencies. Your two examples are Indian rupees, INR (59 to a US dollar, USD), and Pakistani rupees, PKR (100 to a USD).

Everbank, based in the United States, offers foreign-denominated CDs, although not 5-year ones. They're offering an APY of 4.06% for 3 months in Indian rupees. They don't offer Pakistani rupee denominated accounts, but just for some examples: South African rand 4.32%; Norwegian krone 0.13%; and Japanese yen 0.00% (which means it's a pure exchange-rate play, or that you have a known upcoming liability priced in yen). All of those are offered by a US bank. It isn't per country, it's per currency.

So, if you normally work in US dollars, and you want some of that juicy Indian rupee interest, you'll need to convert dollars to rupees (which isn't free), buy the 3-month CD, wait for it to mature, and convert the rupees back into dollars (which not only isn't free, but probably will be at a different exchange rate than three months earlier).

Everbank says Indian inflation is running 6%, so you'd be falling behind by 1.9% annualized plus costs. With a 3-month USD CD from Beal Bank you could earn 0.51%, and with latest reported USD consumer inflation of 2.1% you'd lose out by 1.6%, with no currency conversion risk or cost.

PJW
I see...very interesting! Sounds like what I described isn't specific to those countries, but a broader phenomenon somehow linked to currency and inflation.

1.
I'm reading the Pillars of Investing by William Bernstein, and he talks about Efficient Market Hypothesis. And I was thinking if the EMH concept would apply in general here as well i.e. if these higher rates were very attractive, then everyone would know about it, and everyone would invest there...eventually equaling out any benefit?

2.
Also, I did have a gut-feeling that there would be some caveat/risk to such high bond rates vs US...but I'd like to get a better understanding to where's the catch. Can someone explain in detail or point to some article that analyze this topic with the relevant concepts?
...when I think about it: convert dollars to foreign currency, buy their bond, convert back to dollar after ~10%....I can't understand how the 2% rate here is better?

Thanks!

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Re: Very high interest rate in other countries? How come?

Post by nisiprius » Wed Jul 16, 2014 8:41 pm

Here's what Andrew Tobias had to say about this circa 1976, in The Only Investment Guide You'll Ever Need. It's still valid, just keep changing the names of the countries and currencies. For background, at the time he was writing, bank interest in the United States was capped at 5-1/2% by "Regulation Q" and banks competed by offering account-opening gifts such as the clock radio he mentions
In 'The Only Investment Guide You'll Ever Need,' Andrew Tobias wrote:[A] book explains how by converting your dollars to pesos you can earn 12% on your savings in Mexico instead of 5-1/2% here.... the author reassures, the peso is one of the stablest currencies in the world, having been pegged at a fixed rate to the dollar for 21 years, and the Mexican government has repeatedly stated its intention not to devalue. Now who the heck are you, who needed to buy a book to tell you about this in the first place, supposed to evaluate the stability of the Mexican peso? So, scared of the stock market and impressed by the author's credentials, you take el plunge.

And for 18 months you are getting all the girls. Because while others are pointing lamely to the free clock radios they are getting with their new 5-1/2% savings accounts, you are talking Mexican pesos at 12%.

Comes September, and Mexico announces that its peso is no longer fixed at the rate of 12.5 to the dollar, but will be allowed to "float." Overnight it floats 25% lower, and in a matter of days it is down 40%. Whammo....

(Everything changes and nothing changes. That was 1976. In 1982 the peso was devalued again--by 80%. In 1995, it dropped 55%. From mid-2002 to mid-2004, it edged down 20%.)
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Re: Very high interest rate in other countries? How come?

Post by kayanco » Wed Jul 16, 2014 8:47 pm

ashutosh wrote:The reason for higher interest rates, is because inflation in the countries you mentioned are higher. Banks can pay 10% interest for CD, because it can give out car loan/mortgages at 14%.

Regarding whether this piece of information (i.e. higher interest rates in some countries) can be used to make money, as always, there is no free lunch. There are several risks involved, as some have already pointed out:
a) Currency exchange fees. You lose >2% to transfer USD to other currency and back (my brother lost 1.25% one way, i.e. 2.5% total when converting to INR and back).
b) Tax law change in foreign country. IRS of India does not tax such non residents deposits' interest. May change tomorrow.
c) Currency volatility: Plot Pakistan vs USD or INR vs USD. Its roller coaster all the way.

If you get 2% in US and 9% in India, the difference is 7%. Assuming federal+state tax of 35%, 8% reduces to 4.5%. Loss during currency exchange (which should be deducted from after tax returns) is 2.5%. This leaves 2.0% as MAXimum extra return you can hope to obtain. A currency devaluation of 10% (not so uncommon) would immediately wipe out 5 years of this extra return.
I looked at past 5 years, India, INR per 1 USD, ranges from about 45-60
And Pakistan, ranges from about 85-105 to a dollar

Is there some kind of equation or calculation, to factor in the currency, inflation, etc to see what 2% US equals in these high rate currencies, or vice versa?

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Re: Very high interest rate in other countries? How come?

Post by grabiner » Wed Jul 16, 2014 11:07 pm

kayanco wrote:Is there some kind of equation or calculation, to factor in the currency, inflation, etc to see what 2% US equals in these high rate currencies, or vice versa?
Adjust by the (expected) change in exchange rates. If $1 USD equals 100 PKR this year, and is expected to be 108 PKR next year, then PKR rates need to be 8% higher than US rates for investments to be equivalent. If you invest 10,000 PKR at 10% this year, and then convert the 11,000 PKR back to USD, you will have $101.85, a 1.85% dollar return.

(You may also need to adjust for risk if the investment isn't at the same bank; interest rates on banks or government bonds in less stable countries have to be higher than purchasing power would indicate, because of the risk that the investment won't be paid back.)
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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Thu Jul 17, 2014 4:20 am

The 'carry trade' aka 'Uncovered Interest Parity' works.

You borrow in the low interest rate (low inflation) countries and invest in the high interest rate (high inflation countries). There is (or was) an 'alpha' in that strategy. The currency depreciation does not fully account for the difference in interest rates (long run and the data is 'noisy' --- see below).

However it has been likened to 'picking up nickels in front of bulldozers'-- you make money but every so often you slip and your investment in wiped out. Iceland was paying 15% just before the Crash of 2008. Depositholders in Icelandic banks took big hits when the government could not/ would not bail them out.

Alliance (now Alliance Bernstein) had a couple of bond funds that got caught this way in the 1990s: a 'North American Government Securities' fund which was heavily invested in Mexico when it verged on default in 1994. And a European bond fund that got caught when Spain devalued (Spanish bonds were paying 12%, German bonds were paying 6%, so the fund went heavy into Spain).

India? Pakistan? 5 minutes with the International Herald Tribune, the Guardian, The New York Times would convince you that Pakistan is not a good country in which to lodge your money. Unstable politics. Islamic fundamentalism. Nuclear weapons no one is quite sure who controls them within the country. ISI. Economic disaster area.

(if you are playing that game, Iran is better :happy ;-). But there is this little problem you could go to prison for sanctions busting :happy ;-)).

India is somewhat safer but again a study of its politics and economics would suggest it is anything but risk free. They had a real whoopsie during the 'taper tantrum' in early 2012.

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Re: Very high interest rate in other countries? How come?

Post by richard » Thu Jul 17, 2014 4:59 am

grabiner wrote:
kayanco wrote:Is there some kind of equation or calculation, to factor in the currency, inflation, etc to see what 2% US equals in these high rate currencies, or vice versa?
Adjust by the (expected) change in exchange rates. If $1 USD equals 100 PKR this year, and is expected to be 108 PKR next year, then PKR rates need to be 8% higher than US rates for investments to be equivalent. If you invest 10,000 PKR at 10% this year, and then convert the 11,000 PKR back to USD, you will have $101.85, a 1.85% dollar return.

(You may also need to adjust for risk if the investment isn't at the same bank; interest rates on banks or government bonds in less stable countries have to be higher than purchasing power would indicate, because of the risk that the investment won't be paid back.)
If you are good at predicting exchange rates, you don't really have to worry about any of this, you can make your fortune trading currencies.

Generally, countries which don't issue debt in their own currency (or a currency they control) are riskier than countries that do. If you control your currency, you can just create more money to pay debt. The danger in that case is increased inflation, not default.

There's no such thing as a free lunch.

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Re: Very high interest rate in other countries? How come?

Post by richard » Thu Jul 17, 2014 5:02 am

Valuethinker wrote:<>However it has been likened to 'picking up nickels in front of bulldozers'-- you make money but every so often you slip and your investment in wiped out.<>
This is an image that is well worth remembering for all investing. The problem is a few years of winning tends to make people forget about the bulldozer.

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Thu Jul 17, 2014 5:39 am

Thanks guys for chiming in, this is really interesting discussion for me. And very educating.

I've been reading some of the books on this forum (currently Pillars of Investing), and overall I've developed an affinity to the general ideas:
No free lunch
Risk and reward are intertwined
Markets are efficient for the most part

So I was interested in understanding how these concepts applied to this high interest currency situation....because it wasn't apparent to me. So thanks :)

Oh, and one thing:

I just looked at historical US rates:

Image

Does this mean when it was 15-10%, the US was high risk currency?
And someone other country at that time with lower rate, that would be safer? Meaning, folks in that country would be saying US is higher % than us, because US is high risk country and it's currency is not stable?

Thanks.
Last edited by kayanco on Thu Jul 17, 2014 7:49 am, edited 4 times in total.

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Thu Jul 17, 2014 5:48 am

That reminds me to ask:
Bernstein seems to be a proponent of reviewing history, so we are not that blind sighted by some of the black swans.

So I was wondering what happened to the Bond, CD and stock investments of common folks living in countries where there was war or revolution?

For example, people living in Iraq. I'm sure they had governments bonds, cash, savings accounts, local stock, etc. So what happened to all that after the war and new government came in? Were these assets safe?

Were the gov bonds safe at least?

Or, some of the Middle East countries in Arab Spring, where there were revolutions....were the bond/stock assets safe for those people? I mean for the local people investing locally (like we buy US bonds, CD, stock, etc)

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Re: Very high interest rate in other countries? How come?

Post by Levett » Thu Jul 17, 2014 7:14 am

Richard commented:

"If you are good at predicting exchange rates, you don't really have to worry about any of this, you can make your fortune trading currencies."

This reminds me of the old joke that begins: "Do you know how to make a small fortune in trading currencies?" Answer: "Start with a large fortune!"

;-)

Lev

P.S. And then there's the one about the difference between bonds and bond traders, but that's for another day. 8-)

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Thu Jul 17, 2014 7:18 am

kayanco wrote:Thanks guys for chiming in, this is really interesting discussion for me. And very educating.

I've been reading some of the books on this forum (currently Pillars of Investing), and overall I've developed a affinity to the general ideas:
No free lunch
Risk and reward are intertwined
Markets are efficient for the most part

So I was interested in understanding how these concepts applied to this high interest currency situation....because it wasn't apparent to me. So thanks :)

Oh, and one thing:

I just looked at historical US rates:

Image

Does this mean when it was 15-10%, the US was high risk currency?
And someone other country at that time with lower rate, that would be safer? Meaning, folks in that country would be saying US is higher % than us, because US is high risk country and it's currency is not stable?

Thanks.
You need to read some postwar economic history eg Barry Eichengreen (lots of good stuff on Brad de Long's blog). Also the various Fed banks publish stuff.

1970s inflation had gotten out of control across the western world. early 1980s Paul Volker set out to cure it. Result, highest peacetime interest rates in US history. Switzerland from memory had much lower interest rates, and the currency strengthened at the same time.

Run that chart back to the 19th century you will see peacetime US interest rates were never higher than they were in 1980-81 (Fed Funds rate was 21 per cent. at one point I believe).

What we have been through now looks much more like the 1930s-- global economic and financial crash, very low interest rates to try to revive economy.

However in the 1930s they also had disinflation, so real interest rates were arguably even higher than they are now (where interest rates are more or less tracking inflation). This is a situation you are seeing in Europe right now.
Last edited by Valuethinker on Thu Jul 17, 2014 7:29 am, edited 2 times in total.

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Thu Jul 17, 2014 7:21 am

kayanco wrote:That reminds me to ask:
Bernstein seems to be a proponent of reviewing history, so we are not that blind sighted by some of the black swans.

So I was wondering what happened to the Bond, CD and stock investments of common folks living in countries where there was war or revolution?

For example, people living in Iraq. I'm sure they had governments bonds, cash, savings accounts, local stock, etc. So what happened to all that after the war and new government came in? Were these assets safe?

Were the gov bonds safe at least?

Or, some of the Middle East countries in Arab Spring, where there were revolutions....were the bond/stock assets safe for those people? I mean for the local people investing locally (like we buy US bonds, CD, stock, etc)
Which takes us far, far into politics-- not allowed here.

You might as well mention Iceland, say, or Ireland, which are developed economies that went wrong. The USA is more like them (but Iceland has a population of about 300,000; Ireland about 4 million).

You have to do your own research on what is going on in those countries.

Also you have to consider to what extent you consider the USA to be like Egypt, or Syria, say.

Iraq of course had the privilege of being invaded by the US and UK after a long period of economic and military sanctions-- during that period the government printed money to pay its bills but imposed price controls. However Kurdistan seems to be doing alright since.

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Re: Very high interest rate in other countries? How come?

Post by nisiprius » Thu Jul 17, 2014 7:47 am

kayanco wrote:I just looked at historical US rates: Does this mean when it was 15-10%, the US was high risk currency?
No, it just means there was high inflation. You always need to think in "real" terms, i.e. compensate for inflation.

I once had a CD paying 13.602%,
...but since the inflation rate was 10.3%...
...the real rate of return was only 3.3%.

--it wasn't a high return
--it wasn't a free lunch
--it wasn't too good to be true, and
--it didn't signal any unusual risks.
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Re: Very high interest rate in other countries? How come?

Post by kayanco » Thu Jul 17, 2014 8:21 am

Levett wrote: This reminds me of the old joke that begins: "Do you know how to make a small fortune in trading currencies?" Answer: "Start with a large fortune!"
;-)
Lev
P.S. And then there's the one about the difference between bonds and bond traders, but that's for another day. 8-)
hahaha :p

Yep, I came across this one in one of the books...:D

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Thu Jul 17, 2014 8:36 am

Valuethinker wrote: Which takes us far, far into politics-- not allowed here.
...
Iraq of course had the privilege of being invaded by the US and UK after a long period of economic and military sanctions-- during that period the government printed money to pay its bills but imposed price controls. However Kurdistan seems to be doing alright since.
Yep, I'm not asking about or interested in any political aspects...or any political comparisons or ideas, etc.

I just want to know factually what actually happened to those Bonds/CDs (and land), or what was their fate (as matter of historic record)....just as a simple Yes/No type thing.
Bonds, CD, land, stock that people bought in those countries (Iraq, Middle East), were they safe after the war/revolutions or not?

Why I'm asking?
Because I keep reading governments bonds are safe, so I want to level-set and understand what is the extent of this safety, and under what conditions would this safety break down. Meaning, bonds are safe, only as long as the issuing country (or government?) is safe? Or, are they are safe even if there is war/revolution (i.e. new governments honored these bonds/CD etc)?

(or if someone can point to any reliable online articles discussing what happens or happened to people's assets (bonds and land) after recent wars/revolutions, i'd like to read it)

Thanks.

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Thu Jul 17, 2014 8:57 am

kayanco wrote:
Valuethinker wrote: Which takes us far, far into politics-- not allowed here.
...
Iraq of course had the privilege of being invaded by the US and UK after a long period of economic and military sanctions-- during that period the government printed money to pay its bills but imposed price controls. However Kurdistan seems to be doing alright since.
Yep, I'm not asking about or interested in any political aspects...or any political comparisons or ideas, etc.

I just want to know factually what actually happened to those Bonds/CDs (and land), or what was their fate (as matter of historic record)....just as a simple Yes/No type thing.
Bonds, CD, land, stock that people bought in those countries (Iraq, Middle East), were they safe after the war/revolutions or not?

Why I'm asking?
Because I keep reading governments bonds are safe, so I want to level-set and understand what is the extent of this safety, and under what conditions would this safety break down. Meaning, bonds are safe, only as long as the issuing country (or government?) is safe? Or, are they are safe even if there is war/revolution (i.e. new governments honored these bonds/CD etc)?

(or if someone can point to any reliable online articles discussing what happens or happened to people's assets (bonds and land) after recent wars/revolutions, i'd like to read it)

Thanks.
As a general principle, if a country:

- has a revolution
- loses a major war (or wins one in a costly way)
- undergoes a major restructuring/ default (eg Argentina 2002)/ devaluation (Iceland 2008)

then your money is not safe. Then you get situations like Iceland (not sure of the details) or Cyprus (60% of deposits over 100k Euros) where in a general banking restructuring, depositors got hammered.

Either because of actual default, seizure or freezing of bank accounts, etc. OR because of inflation (and the associated currency devaluation).

There's a handful of government bonds in the world which are held to be really truly safe. Countries that borrow in their own currency, and have a history of repaying debt, including:

- USA
- United Kingdom (but inflation during the postwar years hammered bond returns, you lost something like 95% of your money in gilts 1945-1980)
- Canada
- Australia
- Germany (although the Federal Republic of Germany only dates from 1948)
- Switzerland
- France
- Netherlands

(there are some other AAA borrowers such as Singapore)

At various times many 'blue chip' countries imposed exchange controls (all of the above) even outside of wartime. During wartime (and other times) they also engaged in a deliberate limit on interest rates individuals could receive for investments.

I believe it was Finland that is the only country that was technically at war with the USA (in 1939 USSR invaded Finland, so in 1941-1944 they were allied with Germany against USSR, and the USA was allied with USSR 1941-1945) but resumed payment on its debts post.

http://news.google.com/newspapers?nid=1 ... 127,873472

suggests this was a myth. Finland was not a country until 1919 so I am not sure how they could have 'continued to pay off WW1 debts (it was part of Russia until 1919).

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Thu Jul 17, 2014 8:59 am

kayanco wrote:
Valuethinker wrote: Which takes us far, far into politics-- not allowed here.
...
Iraq of course had the privilege of being invaded by the US and UK after a long period of economic and military sanctions-- during that period the government printed money to pay its bills but imposed price controls. However Kurdistan seems to be doing alright since.
Yep, I'm not asking about or interested in any political aspects...or any political comparisons or ideas, etc.

I just want to know factually what actually happened to those Bonds/CDs (and land), or what was their fate (as matter of historic record)....just as a simple Yes/No type thing.
Bonds, CD, land, stock that people bought in those countries (Iraq, Middle East), were they safe after the war/revolutions or not?
No. Either from seizure, or destruction, or due to the effects of inflation and debt restructuring.
Why I'm asking?
Because I keep reading governments bonds are safe, so I want to level-set and understand what is the extent of this safety, and under what conditions would this safety break down. Meaning, bonds are safe, only as long as the issuing country (or government?) is safe? Or, are they are safe even if there is war/revolution (i.e. new governments honored these bonds/CD etc)?

(or if someone can point to any reliable online articles discussing what happens or happened to people's assets (bonds and land) after recent wars/revolutions, i'd like to read it)

Thanks.
See my other answer. War (losing), revolution, economic crisis-- you are not safe.

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Re: Very high interest rate in other countries? How come?

Post by Beliavsky » Thu Jul 17, 2014 1:41 pm

Valuethinker wrote:The 'carry trade' aka 'Uncovered Interest Parity' works.

You borrow in the low interest rate (low inflation) countries and invest in the high interest rate (high inflation countries). There is (or was) an 'alpha' in that strategy. The currency depreciation does not fully account for the difference in interest rates (long run and the data is 'noisy' --- see below).

However it has been likened to 'picking up nickels in front of bulldozers'-- you make money but every so often you slip and your investment in wiped out.
That depends on how much leverage you use. An unleveraged investment in Australian and New Zealand short term deposits (those are two developed countries that usually have higher interest rates than the U.S.) could fall if those currencies fall, but it won't be wiped out. Enough leverage in any asset class, whether it's stocks, carry currencies, or even government bonds, will wipe you out.

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Re: Very high interest rate in other countries? How come?

Post by kd2008 » Thu Jul 17, 2014 1:55 pm

To OP,

There is no free lunch here. The Indian rupee swung from about 60 to 67 against USD dollar last August. People of Indian origin in the US went crazy and converted their dollars into rupees and earned 9% interest rate. Now that rupee is back to 60, they made out like bandits. Indian government got to avert a run on their currency and got flooded with much needed dollars. But the reverse is equally true.

Indian banks also offer USD denominated CDs (full disclosure: I own a few) and these save you from currency risk. Typical rates for example are seen here:
http://www.sbhyd.com/interest-rates/nri-schemes/ and then select FCNR tab. 5 yr USD CD is 4.68%.

Indian deposit insurance tops at around $2000. Banks in India are mostly stable, esp. public sector banks like the one listed above.

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Fri Jul 18, 2014 9:13 am

Thanks to all who helped me understand!

I have two follow ups:

1.
I was looking at the answers and seems like in summary there are two main risks of buying a high interest foreign currency Bond/CD:
High inflation
Currency risk

Per my understanding, inflation affects a local person, so can we say for a foreign investor, he/she is only exposed to the currency risk, and not affected by the high inflation in the foreign country? Is this understanding wrong?

2.
Regarding inflation, is this understanding correct:
For any asset one owns, it's value should increase above the inflation rate, to be considered a real gain? For any increase in value below the inflation rate, the investor has actually lost money?
Example:
Suppose inflation is 5%, and the value of a home goes up 3% in one year, does this mean the real value has actually gone down?

Thanks.

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Re: Very high interest rate in other countries? How come?

Post by Chan_va » Fri Jul 18, 2014 9:18 am

1. Inflation affects the currency exchange rate. So, if country A's inflation rate was x%, and Country B's inflation rate was y%, then after a year, you would expect that the currency of Country A would appreciate vs. the currency of country B at (x-y)%. So - you are exposed to inflation risk.

2. Yes. Your actual (real) return = nominal return - inflation
kayanco wrote:Thanks to all who helped me understand!

I have two follow ups:

1.
I was looking at the answers and seems like in summary there are two main risks of buying a high interest foreign currency Bond/CD:
High inflation
Currency risk

Per my understanding, inflation affects a local person, so can we say for a foreign investor, he/she is only exposed to the currency risk, and not affected by the high inflation in the foreign country? Is this understanding wrong?

2.
Regarding inflation, is this understanding correct:
For any asset one owns, it's value should increase above the inflation rate, to be considered a real gain? For any increase in value below the inflation rate, the investor has actually lost money?
Example:
Suppose inflation is 5%, and the value of a home goes up 3% in one year, does this mean the real value has actually gone down?

Thanks.

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Fri Jul 18, 2014 9:24 am

Beliavsky wrote:
Valuethinker wrote:The 'carry trade' aka 'Uncovered Interest Parity' works.

You borrow in the low interest rate (low inflation) countries and invest in the high interest rate (high inflation countries). There is (or was) an 'alpha' in that strategy. The currency depreciation does not fully account for the difference in interest rates (long run and the data is 'noisy' --- see below).

However it has been likened to 'picking up nickels in front of bulldozers'-- you make money but every so often you slip and your investment in wiped out.
That depends on how much leverage you use. An unleveraged investment in Australian and New Zealand short term deposits (those are two developed countries that usually have higher interest rates than the U.S.) could fall if those currencies fall, but it won't be wiped out. Enough leverage in any asset class, whether it's stocks, carry currencies, or even government bonds, will wipe you out.
Yes which is why I defined the carry trade mechanism as borrowing and lending.

Agree if you invest in the high yield country you are unlikely to lose all your assets. However 6 years after the Crash, Iceland still has exchange controls so you could still be trapped in there (not sure what has happened to UK depositors in UK subsidiaries of Icelandic banks *inside* the guarantee level (£32000 at that time)). And 12 years after default, Argentina still has not settled with its creditors. Cyprus large depositors are losing 60% of their deposits. Greek bond investors have lost c. 50% I believe in the restructuring. It's not academic that the UK had exchange controls until 1979 and New Zealand certainly had them until then (and, I think later) so even developed economies these risks can show up.

Nickels in front of bulldozers.
Last edited by Valuethinker on Fri Jul 18, 2014 9:34 am, edited 1 time in total.

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Fri Jul 18, 2014 9:29 am

kayanco wrote:Thanks to all who helped me understand!

I have two follow ups:

1.
I was looking at the answers and seems like in summary there are two main risks of buying a high interest foreign currency Bond/CD:
High inflation
Currency risk

Per my understanding, inflation affects a local person, so can we say for a foreign investor, he/she is only exposed to the currency risk, and not affected by the high inflation in the foreign country? Is this understanding wrong?
The two are not independent. Higher inflation means a higher rate of currency depreciation.

In the long run, the price of internationally traded goods in the 2 countries should be the same (Purchasing Power Parity) so the move in exchange rates is exactly the difference in inflation rates. However if that holds, it only holds in the very long run. In effect in the very long run, they are the same risk. The theory doesn't work as well in practice (the short term driver of exchange rates is the difference in expected nominal interest rates, primarily--under Covered Interest Parity if a dollar investors invest in pounds (say a CD) and then buy a currency forward to exchange those pounds for dollars when the pound investment matures (the CD comes due) the cost will be the difference in interest rates between the 2 currencies).

Note the Tokyo haircut problem. Haircuts in Tokyo vs. ones in New York do not obey PPP because they are not tradable goods (to arbitrage the cost of a cheaper haircut, you have to fly from one city to the other). A haircut in Tokyo can, depending on exchange rates, be half or twice the price of one in New York.
2.
Regarding inflation, is this understanding correct:
For any asset one owns, it's value should increase above the inflation rate, to be considered a real gain? For any increase in value below the inflation rate, the investor has actually lost money?
Example:
Suppose inflation is 5%, and the value of a home goes up 3% in one year, does this mean the real value has actually gone down?

Thanks.
To be exact, the relationship is called the Fisher equation after the economist, Irving Fisher

1+ real return = (1 + nominal return) / (1 + inflation)


http://en.wikipedia.org/wiki/Fisher_equation

(that's working out historically what your actual return was)

it can be approximated by

expected real return = expected nominal return - expected inflation

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Re: Very high interest rate in other countries? How come?

Post by Epsilon Delta » Fri Jul 18, 2014 9:54 am

Valuethinker wrote: To be exact, the relationship is called the Fisher equation after the economist, Irving Fisher

1+ real return = (1 + nominal return) / (1 + inflation)

it can be approximated by

expected real return = expected nominal return - expected inflation
1+ real return = (1 + nominal return) / (1 + inflation)

Multiplying by (1+inflation)

(1 + real return) * (1 + inflation) = 1 + nominal return

Expanding:

1 + real return + inflation + (real return * inflation) = 1 + nominal return

rearranging:

real return = nominal return - inflation - (real return * inflation)

Which both shows where the approximation comes from and that Fisher has a sense of humor, since under non-catastrophic conditions that last term is going to involve decimal points.

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Fri Jul 18, 2014 10:57 am

Thanks guys! Really appreciate your kind responses. Thanks :)

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Fri Jul 18, 2014 11:06 am

kd2008 wrote:To OP,

There is no free lunch here. The Indian rupee swung from about 60 to 67 against USD dollar last August. People of Indian origin in the US went crazy and converted their dollars into rupees and earned 9% interest rate. Now that rupee is back to 60, they made out like bandits. Indian government got to avert a run on their currency and got flooded with much needed dollars. But the reverse is equally true.
But suppose it had gone to 120? I think that is what you are saying about no free lunch. We can imagine where Modi fails in some way to achieve the anticipated reforms. Maybe Rajan resigns. Trouble with Pakistan. Etc. etc.

India has had wars with 2 of its neighbours. And political instability in violence in at least 4 of them (Burma, Sri Lanka, Bangladesh, Pakistan). And two of those neighbours are armed with nuclear weapons. 2 Indian Prime Ministers have been assassinated, one by Sikhs, the other by Tamils-- what would India look like if a muslim assassinated Modi? That besides all the known Indian pathologies (huge government subsidies, continuing presence of the license Raj, infrastructure, communal division, incipient asset bubble etc.). India is an amazing place with (I hope) a very bright future, but we are talking here about *bank deposits* and an excess return of (same currency) say 2.5% pa?

I should mention the Naxalite (sp?) insurgents. Because Mexico had NAFTA and all was bullish, the peso ignored reality, Mexico was the next Canada. And then 'Commander Zero' rode into a southern town on a donkey in 1994...
Indian banks also offer USD denominated CDs (full disclosure: I own a few) and these save you from currency risk. Typical rates for example are seen here:
http://www.sbhyd.com/interest-rates/nri-schemes/ and then select FCNR tab. 5 yr USD CD is 4.68%.

Indian deposit insurance tops at around $2000. Banks in India are mostly stable, esp. public sector banks like the one listed above.
I am prepared to believe that there is no way that an Indian government would let a public sector bank fail. However I also remember cases like Cyprus (effectively confiscation of large deposits over 100k Euros, which were (incorrectly) believed to be mostly held by foreign carpetbaggers like Russians).

Maybe it's just me but I can think of scenarios like a freezing of dollar deposits. Or forced conversion into rupees, etc. etc. Equity 'bail ins' a la Cyprus.

I realize these are all nightmare scenarios.

But I keep thinking 'nickels in front of bulldozers'. The market is not being stupid when it pays 4.58% on a 5 year CD from an Indian bank when a US bank pays maybe 2.0%? What makes the US CD attractive (relative to short term US treasuries) is a belief that the FDIC would not be allowed to fail by the US Congress. That's a bet, but it has what I call the Ghostbusters factor

(Bill Murray, arguing to the Mayor of New York why the GBs should be allowed to take on Zool/ the StayPuffed Marshmallow man

'Lenny, you have to understand, this is your chance to save the lives of millions of.....

registered voters' )

Nickels in front of bulldozers. UK Local Councils still have hundreds of millions of pounds tied up in Icelandic banks, 6 years after the Crash.

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Fri Jul 18, 2014 12:05 pm

Hi Valuethinker,

I have to say a lot of this discussion is above my grasp :) ...sounds very advanced and complicated concepts.

Can you give the net-net/summary or take-away of what you are saying?
(regarding investment, not politics :p)

Also, if you mean India/Pakistan government bonds are risky, does that also mean these countries other investments like land/property, stocks, etc are even more risky?
I know land appreciates very rapidly...

Thanks.

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Re: Very high interest rate in other countries? How come?

Post by Beliavsky » Fri Jul 18, 2014 12:38 pm

You can access higher interest rates in other countries and avoid the risk of exchange controls through the currency futures markets, and you can now access the futures markets though Schwab (since it has acquired OptionsXpress). You would need to roll over the futures contracts 4 times a year. The bid-ask spread can be 0.01% for some developed currencies and 0.1% for some emerging market ones. Futures contracts are priced to incorporate interest rate differentials, so the futures contracts on high-yielding currencies trade at a discount to spot levels. Futures brokerages allow you to use a lot of leverage, but you can decide not to let the notional value of your futures positions exceed the equity in your account. Profits and losses on futures positions are treated as 60% long term and 40% short term capital gains and losses, which is better than having all interest taxed at ordinary income rates.

Similarly, you can get government bond exposure through Treasury bond futures contracts and stock market exposure through stock index futures contracts. For long-term investors, it is better tax-wise to physically own stocks through a fund than synthetically through futures.

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Re: Very high interest rate in other countries? How come?

Post by magician » Fri Jul 18, 2014 6:58 pm

Beliavsky wrote:My reading of the academic research is that higher interest rate currencies tend to depreciate against lower rate ones, but by less than the interest rate differential. So it has been profitable to own higher rate currencies, but the profit has been less than the nominal rate spread.
Hence: carry trade.

Which works well . . . until it doesn't. And when it doesn't, it doesn't in spades, disastrously.
Simplify the complicated side; don't complify the simplicated side.

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Re: Very high interest rate in other countries? How come?

Post by magician » Fri Jul 18, 2014 6:59 pm

Beliavsky wrote:You can access higher interest rates in other countries and avoid the risk of exchange controls through the currency futures markets, and you can now access the futures markets though Schwab (since it has acquired OptionsXpress). You would need to roll over the futures contracts 4 times a year. The bid-ask spread can be 0.01% for some developed currencies and 0.1% for some emerging market ones. Futures contracts are priced to incorporate interest rate differentials, so the futures contracts on high-yielding currencies trade at a discount to spot levels. Futures brokerages allow you to use a lot of leverage, but you can decide not to let the notional value of your futures positions exceed the equity in your account. Profits and losses on futures positions are treated as 60% long term and 40% short term capital gains and losses, which is better than having all interest taxed at ordinary income rates.

Similarly, you can get government bond exposure through Treasury bond futures contracts and stock market exposure through stock index futures contracts. For long-term investors, it is better tax-wise to physically own stocks through a fund than synthetically through futures.
Note that currency futures are usually priced based on interest rate parity, so you shouldn't do any better than you would investing in your home currency. The only advantage would be, as you mention, the tax treatment.
Simplify the complicated side; don't complify the simplicated side.

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Re: Very high interest rate in other countries? How come?

Post by Beliavsky » Sat Jul 19, 2014 9:28 am

magician wrote:Note that currency futures are usually priced based on interest rate parity, so you shouldn't do any better than you would investing in your home currency. The only advantage would be, as you mention, the tax treatment.
Over long periods of time, high-yielding currencies have not depreciated by less than their yield differential, so you would have done better than investing in USD money market funds. There have been academic studies of the "carry trade". I'm not saying it's risk-free. Neither is investing in stocks.

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Re: Very high interest rate in other countries? How come?

Post by Beliavsky » Sat Jul 19, 2014 9:42 am

magician wrote:
Beliavsky wrote:My reading of the academic research is that higher interest rate currencies tend to depreciate against lower rate ones, but by less than the interest rate differential. So it has been profitable to own higher rate currencies, but the profit has been less than the nominal rate spread.
Hence: carry trade.

Which works well . . . until it doesn't. And when it doesn't, it doesn't in spades, disastrously.
The same could be said about stocks -- look at 2008.

The paper Carry Trade and Momentum in Currency Markets (2011) by Burnside et al. looked at the returns of a
carry portfolio diversified over 20 major currencies over the period 1976-2010:
Consider, first, the equally-weighted carry trade strategy. This
strategy has an average payoff of 4.6 percent, with a standard deviation of 5.1 percent, and
a Sharpe ratio of 0.89. In comparison, the average excess return to the U.S. stock market
over the same period is 6.5 percent, with a standard deviation of 15.7 percent and a Sharpe
ratio of 0.41.

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Re: Very high interest rate in other countries? How come?

Post by kayanco » Sat Jul 19, 2014 9:53 am

Whoa!

I read some more one this, and also found this article by Mr. Larry Swedroe, Perils of the Carry Trade:
http://www.etf.com/sections/index-inves ... trade.html

Looks like what I described in my OP, which was just a thought/query I had, is actually a whole phenomenon and strategy...lol...very interesting...

...I also stumbled upon those commodities threads with fierce debates between Larry Swedroe and Rick Ferri. That was another revelation to me! I had thought that there is unanimity amongst the experts, but no :p ....the more I read, the more it's like a rabbit hole, LOL

But I have to say I love Bogleheads! I want to give a big hug to Bogleheads!

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Re: Very high interest rate in other countries? How come?

Post by Valuethinker » Sat Jul 19, 2014 10:18 am

kayanco wrote:Hi Valuethinker,

I have to say a lot of this discussion is above my grasp :) ...sounds very advanced and complicated concepts.

Can you give the net-net/summary or take-away of what you are saying?
(regarding investment, not politics :p)

Also, if you mean India/Pakistan government bonds are risky, does that also mean these countries other investments like land/property, stocks, etc are even more risky?
I know land appreciates very rapidly...

Thanks.
1. when you invest in a country you take on that country's political and economic risk. Now if you invest through a globally diversified index fund then that's just part of the risk of investing. From time to time it will crop up, but if a market collapses there may be other places you are losing money.

But if you specifically invest in deposits in the currency of a country, you better have a pretty good idea of what the risks are. What I am talking about is what you learn by reading the International Herald Tribune, the Economist, the FT, the New York Times-- no more than that. Even The Economist alone would probably give you that.

2. If you invest in the land or equities of a country you have other risks. However with deposits you can go to zero (you can too with stocks, but not usually stock market indices except in the case of revolution and confiscation). Land you can have it taken away from you, of course, but generally it will be worth *something*.

So if you invest in land or equities you have (theoretically) unbounded upside, as well as downside. With a deposit or a bond, you can only get your money back plus the interest you are owed. I prefer to have my exposure to countries like India via well diversified global equity funds, than by trying to make money on bank accounts that pay 4% pa more interest.

Whether you can get that money out that you have invested is a whole another problem. Another reason not to be above market weight in countries that have big political and economic risks.

BTW land does not always go up. Try Spain the last 7 years for an example.

Maybe I should put it this way. You don't get higher return without higher risk. Countries whose banks pay higher deposit rates are either at risk of currency devaluation (wiping our your additional return, or worse) OR at risk of bank default/ exchange controls. Or both. Travel with care.

An important exception is that FDIC insured bank deposits in the US, for small investors, can beat US Treasury securities of the same maturity in yield.
Last edited by Valuethinker on Sat Jul 19, 2014 12:25 pm, edited 1 time in total.

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Re: Very high interest rate in other countries? How come?

Post by Johno » Sat Jul 19, 2014 12:03 pm

Beliavsky wrote:
magician wrote:Note that currency futures are usually priced based on interest rate parity, so you shouldn't do any better than you would investing in your home currency. The only advantage would be, as you mention, the tax treatment.
Over long periods of time, high-yielding currencies have not depreciated by less than their yield differential, so you would have done better than investing in USD money market funds. There have been academic studies of the "carry trade". I'm not saying it's risk-free. Neither is investing in stocks.
Agree. Currency futures are priced strictly* on covered interest arbitrage. However that doesn't mean you're equally likely to make money if you take an unhedged position in the futures in either direction. History shows you tend to make money going long the higher interest rate currency (essentially borrowing $'s, if it's a USD/FX contract, at LIBOR to invest at [blank]IBOR of the other currency). There's no fundamental reason to think there can't be market tendencies like that. You're taking risk of loss to get what history says will probably be a positive return, which is also what you're doing when you buy stocks. Different kind of risk, might or might not be better/worse on mean variance basis as a standalone, might or might not favorably diversify your overall risks.

When it comes to currencies exotic enough not to have exchange traded futures, IMO that would be a signal to most individual investors to proceed very cautiously, because whatever tailored instrument a financial institution sets up for a retail investor to take such risk, they are probably viewing it as a high profit margin product, for them of course. As long as you can do it with futures, the transactions costs are quite low (with the lowest cost brokers) and it's a question of whether the basic trade works or not.

*with very small bands of price where transactions costs of professional traders offset the arbitrage

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