Strong currencies are supposed to do two things: appreciate in the long term and act as hedges when macroeconomic conditions deteriorate. We analyze the 5 strongest currencies in the world.
- What makes a currency strong?
- The 5 Strongest Currencies in the World
What makes a currency strong?
There is no single rule to determine which are the strongest currencies in the world. But most of us would agree that they should share some characteristics and features
The two determinants we are going to analyze are of fundamental and tail hedge nature. On the one hand, fundamentally strong currencies would have to appreciate against all others in the long term.
On the other hand, a strong currency is also one that massively appreciates in times of economic turmoil. In summary, they act as a safe haven asset.
There are several fundamental factors that make a currency strong. A low level of inflation is key, as it makes it possible for purchasing power to be preserved over time. This usually goes hand in hand with limited monetary expansion. Central bank monetary expansion is not positive for the value of a currency. This is about monetary policy.
Fiscal policy also matters. This is about the level of public debt and deficits in a country. In general, the lower the public debt and fiscal deficit, the better. Precarious public finances often lead to an eventual currency devaluation.
It is important for a country to be welcoming of foreign investment capital. Rule of law and attractive investment conditions attract foreign capital into the country. This is supportive of a currency’s value as it bids up its assets and other productive resources
We also want the country to be in a positive trading position. Enjoying trade surpluses is very supportive of a currency, since it means that that country exports more than it imports, and that leads to the currency being bought more often that it is sold.
Additionally, countries that enjoy healthy trading positions tend be less indebted with the rest of the world, reducing the probability of a unilateral currency devaluation.
Finally, there is a more intangible factor. This is related to a country’s geopolitical situation and the role and reputation of its currency in the financial markets.
If we take those 5 metrics or factors into account, we can identify what makes a currency strong or weak. A currency does not need to meet all 5 criteria in order to be strong though. And these metrics are always relative as the value of one fiat currency is always quoted relative to other fiat currencies.
Ability to appreciate against other currencies in the long term
A very useful rule of thumb is to check a currency’s historical track record. While foreign exchange markets are very volatile in the short and medium terms, long term patterns are clearly established and tend to last for multiple decades.
The easiest thing is to simply look at a currency’s value against the US Dollar. Some currencies have been constantly appreciating over long periods of time. While most currencies have been steadily losing value.
For example, while the Swiss Franc has been getting stronger against the US Dollar for decades, other relatively strong currencies such as the Pound Sterling or the Canadian Dollar have been going down against the greenback, even though they may have enjoyed long periods of relative strength.
How they react to an economic crisis
Similarly, we also want to know what happens to the value of a currency in the event of an economic or financial crisis. This is a very useful feature if we are looking for safe haven assets.
Safe haven assets tend to appreciate when there is an economic, and that helps us cushion the blow we may experience in other investments we have. In addition, safe haven assets allow us to have dry powder to buy cheap assets after a crash.
Interestingly, how currencies are likely to react to negative macroeconomic events is quite predictable. This is because currency movements respond to the way investors and other economic agents are positioned during the cycle.
The 5 Strongest Currencies in the World
Let us see our top 5:
Swiss Franc (CHF)
The Swiss Franc is considered the single strongest currency in the world. Switzerland is a country of just 8.5 million people. However, the Swiss Franc enjoys a unique position in the financial markets.
Switzerland is one of the richest countries in the world as well as one of the most stable. If there is a safe place where we can store our assets, this is Switzerland.
Moreover, the Swiss trade surplus is very strong. Switzerland manages to sell abroad much more than it imports. This is impressive since the country does not have any natural resources. According to the CIA World Factbook, Switzerland exports 20% more than it imports, year after year.
At the same time, Switzerland’s public finances are extremely healthy. Its public debt is equivalent to only 46% of its GDP. And it is very common for the government to have public surpluses. That helps keep inflation low.
Regarding monetary policy, although the Swiss National Bank has expanded its balance sheet tremendously since the 2008 financial crisis, this has not led to a devaluation of the currency. This is because, unlike the United States or the Eurozone, this monetary expansion has not been aimed at buying their own government debt.
Monetary expansion in Switzerland has had the goal of preventing the Swiss Franc from strengthening even further. The Swiss National Bank has been printing Swiss Francs, exchanging them for other fiat currencies and using that money to buy financial assets from all around the world.
Anecdotally, the Swiss central bank is one of Apple’s largest shareholders. And the Swiss government receives part of those dividends.
It should be noted that the Swiss Franc is usually one of very currencies that increase in value when there are problems in the financial markets or geopolitical instability in the world. The Swiss Franc is probably the only currency in the world that meets all 5 criteria detailed above.
Japanese Yen (JPY)
The Japanese Yen is another currency whose value skyrockets when there are problems in the world, alongside the Swiss Franc and the US Dollar. It is also one of the currencies that has appreciated the most against the US Dollar over the last few decades.
Even though Japan has experience very low economic growth since the early 1990s, it has never ceased to be an exporting superpower. This has resulted in large trade surpluses and kept the demand for Yen very strong.
Something very positive about the Japanese Yen is that Japan has experienced almost no inflation since 1990. As a result, the purchasing power of the currency has remained largely intact.
Regarding monetary and fiscal policy, we must emphasize that Japan is the country with the highest level of public debt in the developed world. That has led the Bank of Japan to expand the money supply absorb most of that government debt.
While this monetary expansion is not positive for the currency, the Japanese public has a very high savings rate. As a result, Japanese people are saving the very currency that the central bank is creating to buy Japanese government bonds.
In fact, Japan has enough domestic savings to finance all its public debt. Not only that, but Japan is also the largest foreign holder of US Treasuries. Japan owns about $10,000 of US Treasuries for every Japanese citizen.
Japan is also a very stable country from a political, economic and rule of law perspective.
Additionally, because it has had extremely low interest rates for a very long time, many investors like to borrow the Japanese Yen to invest in other markets. When there is an economic crisis, there is a wave of margin calls, and these investors are forced to pay back much of their debt denominated in Japanese Yen. This bids up the currency, leading to its appreciation.
Czech Koruna (CZK)
The Czech Koruna is the currency of the Czech Republic. The Central European country is one of the best economic success stories since the fall of communism over three decades ago. And its currency has benefited from that.
The Czech Republic enjoys a very strong economy, with a high level of exports, high economic growth rates and enviable public finances.
In fact, if we look at Czech macroeconomic data, we will realize that it has many things in common with Switzerland, including very attractive conditions for foreign investors. In a way, the Czech Republic is a poorer version of Switzerland.
The Czech currency has appreciated almost 100% against the US Dollar since the turn of the century. And it is worth highlighting that it has not traded higher because the Czech central bank has been taking action to achieve that.
This is because the Czech Republic exports mostly to Eurozone countries. A significant strengthening of the currency against the Euro would make its exports a lot more expensive and could lead to economic problems.
Although the Czech Koruna will not rise in value in times of economic stress, it will remain fairly stable. And, unlike most European countries, the Czech Republic is unlikely to implement massive monetary expansion to combat a recession.
Singapore Dollar (SGD)
Singapore is one of the richest countries in the world. And its currency one of the strongest. The Singapore Dollar is tremendously stable and has been appreciating against the US Dollar for decades.
Singapore is a small group of islands with just over 5.5 million people. Its public finances are in perfect shape as the country has no net debt. Rule of law is also extremely high.
Something Singapore takes pride in is managing the country to maximize its long term economic success. The Asian country is not obsessed about the next election cycle but wants to do what is best for the upcoming generations.
US Dollar (USD)
Obviously, the US Dollar had to be in our top 5 of strongest currencies in the world. However, its fundamentals are a lot different than those of the other four currencies we have discussed.
The US Dollar is the world’s reserve currency. This means that most countries keep its foreign reserves mostly in dollars. This special status makes the Dollar one of the strongest currencies in the world.
At the same time, another great advantage of the Dollar is that many governments and corporations outside the United States have dollar-denominated debt. This creates a floor for Dollar demand in the world.
Although the Dollar has been losing value against goods and services for many decades, it is one of the currencies that has done best relative to others. Additionally, it tends to gain in value in terms of financial crisis and geopolitical turmoil.
When it comes to the United States fundamentals, they are quite weak. The level of public debt in the United States is extremely high and rising every year.
At the same time, the United States has the largest trade deficit in the world. In other words, it imports much more than it exports. This leads to a growing amount of Dollars in the world, which puts downward pressure on its value.
Something very positive for the US Dollar is that the United States is generally in a better position to raise interest rates than most of its peers. The US is better able to increase borrowing costs than places like the Eurozone, Japan, the United Kingdom or Canada.
Higher US Dollar interest rates creates more demand for dollar-denominated assets, leading to an appreciation of the greenback relative to other currencies.
If you like this information, I encourage you to subscribe to my newsletter: