The Pros and Cons of Investing in the Colón

July 9, 2010

In the face of economic uncertainty in the developed world, investors, especially those who fear inflation in the United States and Europe, are looking for new places to park their money. And while local experts pitch Costa Rica as a stable and growing economy, they also say that Costa Rica’s currency, the colón, is not a good investment.

“We have a very volatile currency,” said Carlos Fernández, general manager at Financiera Acobo, a Costa Rican investment firm. “Today, there could be an exchange rate of ¢525 to the dollar and tomorrow it could be at ¢550. That’s the risk of investing in the colón.”

Instead, financial experts like Fernández suggest an investment in the state’s telecommunication company, which he considers safe and gives returns of upwards of 7 to 8 percent in dollars. But you won’t be getting away from the U.S. greenback, he said, as most people and businesses in Costa Rica are moving toward the dollar.

 

The View From the U.S.

 

There’s a growing belief in the United States that the dollar may lose much of its value, due to record government deficits and enormous private sector debt.

“We have 60 trillion dollars of liability,” said frequently-quoted economist, Jim Rickards, in an interview with CNBC cable television network last year, adding together all debt in the U.S., including mortgages, student loans, etc. “There is no feasible combination of growth and taxes that can fund those liabilities.”

He said in a later interview with King World News, “What you can do is inflate the debt away, which is a little scary.”

Oscar Ugalde, an economist at Costa Rica’s National University (UNA) and the Latin American University of Science and Technology (ULACIT), said there’s no evidence that the U.S. Federal Reserve will trigger hyperinflation by rapidly printing money.

“An important concern exists among senior economists as to whether the (U.S.) Federal Reserve will become the ‘lender of last resource’ for Obama’s presidency to finance the highest budget deficit in U.S. economic history,” he said. “Yet, recent interviews with Ben Bernanke, chairman of the Federal Reserve (the United States’ central bank), show that there are no serious intentions to significantly increase the money supply.”

Despite the argument that the dollar may lose value, others say the dollar is a worldwide currency and, therefore, cannot lose value overnight. They point to the crisis in Europe and say it will lead more people to hold money in dollars. Also, oil and other commodity contracts are made in dollars, giving the currency added stability.

 

Still Looking for an Out?

 

Nevertheless, many North Americans, rattled from the recession and with a depreciating confidence in the U.S. economy and banking system, are looking for creative alternatives.

And Latin America, including Costa Rica, with its relatively pro-business, pro-growth, open market mindset, is becoming an alluring option.

“We have seen many Americans looking for deals here and a place to diversify their investments,” said Juan Pablo Segura, an analyst at the Costa Rican financial firm Aldesa. “People are becoming scared about the volatile market in the United States.”

Yet, like Fernández, Segura steers his clients away from the colón.

“We don’t feel comfortable advising people to invest in colones. We don’t have many participants in that market,” Segura said. “If you are an American investor and, in the end, you need dollars, we would suggest something that isn’t as volatile.”

The colón fluctuates at such a rapid pace because of the small size of the market, Segura said. One big purchase or big dump of the Costa Rican colón can affect the value of the currency, resulting in shortages or surpluses in the stock of money.

Those who plug their money into the colón one day, have no guarantee that they will make any money back in dollars on the day they pull it out. “However, there are incentives to invest in the colón,” said Segura, as a 5-year government bond in colones is now fetching a 10.78 percent return whereas local bonds in dollars go for 5.35 percent.

From a purely mathematical perspective, Ugalde said the colón is more attractive than the dollar. The reference interest rate in Costa Rica is 8.25 percent, versus a .75 percent federal funds rate in the United States. Even if you factor in the present rate of inflation – Costa Rica’s inflation rate is 5.6 percent versus 2.02 percent in the United States – there is a net 3.92 percent financial benefit to investments in the colón.

“(In either dollars or colones), we are talking about yields that are far greater than (those offered by) the U.S. Treasury,” Segura said, “But by investing here, you are incurring a certain amount of country risk. I feel comfortable investing in a bond, but I am not sure a North American would feel the same.”

But, while some might be moving away from the United States’ currency, Costa Rica seems to be moving toward it.

 

An Economy that Favors the Dollar

 

“Everyday there are fewer colones in Costa Rica,” said Fernández. “The amount of dollars that are out there is impressive. Just about all the investments received by banks are in dollars.”

He added, “We are moving closer to (de facto) dollarization each day.”

Segura said that although the private sector might favor the dollar, there’s little risk in the disappearance of the colón, at least in the next four years.

Having a separate currency allows Costa Rica a financial independence that countries, that have turned to the dollar or the Euro have lost.

“When the government doesn’t have the liberty to print their own money, they are handcuffed,” he said.

And even though Costa Rica’s economy is small and its currency is vulnerable to swings, that independence might prove attractive for investors seeking alternatives to the debt-ridden U.S. financial system.

clong@ticotimes.net

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