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1. I am a fund manager. How can I use the SCB?
Any international investor or fund manager can follow every market worldwide in SCB terms and make investment/trading decisions based on it. This will reduce the complexity of the investment problem because no longer will you have to analyze a single bet that incorporates both the market and its currency. Say you're comparing real estate in Tokyo and London. By measuring them in SCB terms, you level the playing field. The SCB normalizes the fluctuations of the yen and pound for you; you look at true values in common terms. You will own or short a given market in its local currency, but you will measure the asset's value in SCB terms. This means that as far as assessing the underlying value, the local currency's fluctuation will no longer cloud the picture. You will also assess the currency and its likely direction -- as a separate process.
2. How might the SCB affect monetary policy?
If the SCB catches on, central banks will have less temptation to steal value through inflation.The SCB exposes each government as the steward of its currency. So the SCB ultimately serves to make central banks more responsible. In 2004 San Franciscans thought they were making a killing in real estate, but once they factored out the dollar, it wasn't so impressive. Mexicans may think they are making money in the rising Bolsa, but they're not; they're just breaking even due to the fall in the peso. When people use their home currency as a benchmark, they don't see their loss of value when it's inflated; they still have X currency units in the bank. That mistaken impression is corrected when they use the SCB as an additional measure.
Granted, the central bank of an SCB country has a slight advantage: Its presence in the SCB softens the footprint of any value changes, though not by much. The four SCB currencies each make up a quarter of the benchmark. This means that 75% of any value erosion shows up in a head-to-head comparison of the currency and the SCB. Plus, obviously if a central bank wants to maintain its currency's slot in the SCB, it has to manage its currency well or it will lose its position just as a company's directors can see its stock deleted from the DJIA.
3. How do I use the SCB to compare bonds?
The formula would be price x yield x SCB. That will let you see the real story between, for example, Mexican bonds that are yielding, say, 20% and Swiss bonds that are yielding zero. Swiss bonds were the better buy in 2004, because the peso contracted 19% in SCB terms in '04 while the Swiss Franc expanded 4%. This gives you yields in SCB terms of 1% and 4% respectively. These numbers are hypothetical, but you get the idea.
If you want to get highly specific, you expand the formula as follows: price x (1+yield) x (holding period/1 year) x SCB.
That leads you to the proper formula for comparing anything in SCB terms. For individual stocks, for example, you'd calculate: price x (1+dividend) x SCB.
To see exactly how the SCB is calculated, click here.
4. What would make EWI change out one currency for another in the Stable Currency Benchmark?
Switching currencies in and out of the SCB every time their “fundamentals” appeared to change would render the SCB useless as a benchmark. Worse, because good fundamentals attend tops and bad ones attend bottoms, the index would repeatedly take on new components at tops and unload them at bottoms, which is how most people lose money in their portfolios. The point of SCB is to let the fluctuations cancel out so that you have a stable unchanging yardstick by which to measure things. To create the SCB we chose currencies that had the best long-term situationsfrom many points of viewin their respective global quadrants. Nevertheless, we can imagine a shift in the conditions that caused us to include a currency in the SCB in the first place, such as a military coup, a communist takeover or a monetary authority beginning a policy of replacing debt paper with currency (as Germany did in the early 1920s). Any such events would render a currency hopeless for the purposes of stability and disqualify it for the SCB.
5. How can I invest in the SCB?
For a discussion of the specifics surrounding the Stable Currency Benchmark as an investment, please see the sister site at stablecurrencyindex.com.
Set up a bank account in each SCB country and fund it.