The Risks of Living Abroad on Foreign Currency

Today, a reader brought up a very valid point that I'd like to share with everyone and then discuss.

Reader's Comment

As an Argentinian I can say that I agree with what is stated in this post. The only thing I would like to say to this possible expat is that his U$S 1000 will be tied to the exchange rate against our local currency, the Argentinian peso. This is about 3 to 1 nowadays, but it could change. Most likely the peso will stay as it is now or will devaluate. But no one can give a 100% guarantee that will be the case...

Currency Risk

When you're living or doing business in one country, but your primary income is from another country, you have currency risk. If the value of your home currency declines relative to the value of the country you're living / doing business in, you're going to be in trouble. Even normal currency fluctuations are going to cause your income to go up and down on a regular basis.

My business faces this exact situation every month. I earn the vast majority of my income in dollars from US businesses. Then, each month, I have to do a foreign currency exchange from dollars to pesos. Thus, my Argentina expenses vary by a few hundred dollars each month, depending on the exchange rate at the time. Sometimes the rate swings in favor of the dollar and I pay less, other times it swings toward the peso and I pay more.

If I were a large multinational corporation, I'd probably buy a currency option with a bank to protect myself from these currency swings. I choose to risk it. International banks aren't interested in writing currency options for small businesses. If your sales aren't in the tens of millions, you really don't have a lot you can do about currency swings. Now, if I was truly worried, I could take 2 or 3 years operating expenses and convert to pesos right now, locking in today's rate. I don't want to tie up that much capital in pesos, however, so that's not an option for me.

What Else Can Be Done

There are some things you can do to make this a less frightening situation. One of my office's biggest expenses is rent. I removed the currency risk from this expense by signing a lease in dollars with my landlord. See, some Argentine companies are also fearful that the peso could further drop in value, so they are willing to make a contract with you in dollars. When you do this, you shift currency risk from yourself to the landlord.

Since I earn my income in dollars, there is no risk for me to pay in dollars. The landlord takes the risk that the dollar will fall in value versus the peso and he'll be earning less in peso-terms, should the peso strengthen against the dollar. As the risk taker, he also has the reward should the peso decrease in value, relative to the dollar. In that case, I'll be paying more each month than I would had I signed a lease in pesos.

I don't care about this, however. As an technology consulting company, I don't care if I could have made some money by the peso's fall. I am not in the currency speculation business. I would much rather have someone else take potential currency gains in order to protect myself from potential currency losses. I like to have predictable and stable expenses each month. So, anytime I can pay for something in dollars, I jump at the chance. I'd rather have someone else take the currency risk than me take it.

Implications For Retirees

Retirees are going to be faced with this same problem. Their pensions are providing them income in dollars, not pesos. If the peso strengthens against the dollar, they'll find themselves with less spending power here in Argentina. Just like my business takes steps to lessen this risk, retirees can do the same.

First, retirees can ask to sign their leases in dollars. With the most recent bout of inflation happening, there's probably even more landlords willing to do this. As a retiree, your rent will be one of the largest expenses you have. Most people spend 25-33% of their total income on housing. By paying your housing expense in dollars, you've taken a large portion of your income off the table as far as currency risk is concerned.

You can also convert a larger amount of your money to pesos when you think the exchange rate is in your favor. Suppose it has been hovering along at 2.9 for awhile and it goes to 3.0. You could very easily convert 6 months worth of living expenses at that time and protect yourself for the next six months from any further drop. Keep in mind, however, that should the dollar strengthen even more and go to 3.1, you've just lost out.

The Good News

Unlike devaluations which rapidly cause a currency to sink in value, re-valuations take a lot of time. In 1991 when the Argentine government instituted the 1:1 convertibility program, citizens had to trade in their old australes at a fixed exchange rate for the new pesos. Similar to the conversion to euros in Europe, the prices of every good and service were also switched over from australes to pesos at the same fixed exchange rate (or maybe plus or minus a few percentage points in either direction).

After the switch over, the real buying power of all the citizens stayed the same. If the Argentine government were to ever try to re-value the peso, a retiree's buying power in dollars would still be the same. A return to 1:1 would be a very gradual process, much like the euro's strengthening against the dollar. First we'd see rates at 2.8:1, 2.5:1, 2:1, and 1.5:1 over a course of months and years. A retiree's buying power would be gradually declining over this period as the peso strengthens against the dollar.

Realistically, there would be no way for you not to notice. Each month you'd be forced to make larger and larger exchanges of dollars to pesos just to meet your basic monthly expenses. Eventually you'd decide that it was no longer affordable to live in Argentina and you'd have to find somewhere else to go where your $1000 USD would give you good buying power.

So, there is no need to worry that you might come to Argentina today and find that next week your dollars only buy 1/3 of what they used to. That is, of course, unless the USA suffers a huge and rapid devaluation. I won't get into that right now, since that is another topic all together...