Currency structures threaten markets, leading manager warns

Sarasin & Partners' CIO Guy Monson has highlighted 'inflexible and outdated currency structures' as the greatest headwind facing the global economy.

In fact, Monson anticipates that 58% of the world is in direct or indirect dollar pegs which are increasingly distorting trade and capital flows. He uses China's undervalued renminbi as a notable example.

'Even as the global recovery broadens and deepens, the world economy remains distorted by rigid currency structures that continue to drive trade and capital flows. The largest of these remains China's undervalued dollar peg that generates vast trade surpluses which have been amassed into a war chest of reserves ($2.5 trillion). While such excessive surpluses would typically cry out for a revaluation, heated politics and a nervous export lobby ostensibly remain in the way.

'The China Council for the Promotion of International Trade showed that the most labour intensive export sectors only had margins of 3%, and anything but a notional appreciation could cause many to close,' Monson said.

Monson is keen to point out that China's mercantilist behaviour not only distorts US-China bilateral trade, but also affects the emerging market world which is desperate to maintain its competitiveness.

A general theme going forward is likely to be further 'blow-ups' in structurally distorted areas which will find it difficult to restructure without flexibility in currency or interest rate, in Monson's view. Key among which is the Eurozone which Monson describes as a 'similarly rigid currency arrangment' in the Eurozone, a disparate economic region where peripheral states need wage and price deflation to match Germany's competitive position, in his view.

'While we have (finally) seen a €45 billion package for Greece, the resurgence of political turmoil in Latvia (which just a year ago faced a Greece-like choice of devaluation or austerity) shows the danger of longer-term political instability that comes from remaining in a rigid currency arrangement.,' Monson said.

The Sarasin EquiSar Global and Sarasin EquiSar - IIID manager believes the issue for Greece is not in fact the funding crisis dominating the newspapers at the moment, but rather the longer-term political instability that will accompany the austerity measures.

Although Chinese currency revaluation will take place eventually in Monson's view, accompanied by tighter money and stronger currencies in the rest of the emerging markets and 'an enhanced fiscal union across the Eurozone', the scenario is likely to be complicated by domestic and international politics which will prove the real drives or reform.

'There is also a risk that when change comes, it will be disorderly or chaotic and that extreme currency volatility lifts overall market volatility,' Monson argues.

Against this backdrop in which the use of special liquidity instruments and currency intervention will result in abnormally generous liquidity conditions, Monson recommends holding emerging market short-dated bonds and currencies alongside high quality global growth stocks with good cashflow and dividend growth which are focused primarily in the West.

Monson is particularly bullish on supranational bonds denominated in emerging markets currencies, for example the European Bank for Reconstruction and Development (EBRD) 2013 which yields 9.25% in reais.

Over the three years to the end of March, Monson and co-manager Harry Talbot Rice have posted a 19.4% return with the Sarasin EquiSar - Global fund in sterling terms, while the FTSE World index was up 15% over the same period according to Lipper.