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For example, the top interest rate for margin loans as of today in AUD is currently set to 1.5%, while for ZAR the interest rate is set to 8.057%. That is a huge difference. If I were in South Africa, why would I ever take out a margin loan in ZAR when I could have it in AUD at a much lower interest rate?

Personally, I'm in the United States and the base currency of my account is in USD, whose interest rate is set to 1.59%. But if that USD interest rate were ever to significantly increase relative to some other currency, why shouldn't I switch my loan to that currency instead? I understand that this would expose me to currency fluctuation risk, but over the long term, unless there is a catastrophe in one of the currencies, shouldn't these fluctutions even out?

  • Does IB permit you to borrow in a foreign currency and purchase domestic shares denominated in another currency? How does that work? Is there a currency exchange involved? If so, is there a fee for that? Just curious how this works ... – Bob Baerker Jan 13 '21 at 22:00
  • Well, not buy domestic shares denominated in another currency, but you can convert the foreign currency into the domestic currency before buying the domestic securities. The fee for exchanging currencies is the same as everywhere else: the bid-ask spread. Or you could just use the foreign currency to buy securities in a foreign exchange. –  Jan 13 '21 at 22:10
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    Axio, the fundamental answer to your question is indeed that the assumption in your final sentence is (unfortunately!) just wrong ... and that's it ! – Fattie Jan 14 '21 at 15:06
  • @AxiomaticNexus You're like asking why should a person invest in South Africa Stock Market, when the person can borrow AUD and invest in Australia Stock Market. By your logic, the whole planet should just borrow EUR and invest in Europe Stock Market simply because the margin rate is lower. Do all Stock Markets actually have equal performance on a hedged and unhedged basis? No. – base64 Jan 14 '21 at 15:16
  • I don't see any reason to downvote this excellent question BTW. As base64 says: the OP is essentially just asking: "I know for sure currency XYZ is going to go to price PPP, should I make a massive whole-life-value vet on that?" The whole house/loan aspect is of no consequence. (the money saved/lost by the interest rate difference wouldn't even show up compared to the money won/lost on the currency trade.) – Fattie Jan 14 '21 at 15:24
  • @base64 Not the whole world, but people with domestic markets whose performance is comparable to foreign markets, yet, whose domestic interest rates are significantly higher. For example, the hypothetical South African investor. Looking at the MSCI South Africa Index, it has had an annualized return of 8.52% over the last 20 years; this is comparable to the S&P500, or any broad European or Australian Index. How does it make sense to borrow at a 8.057% interest rate to invest in my domestic market, when I could borrow at 1.5% and get similar returns in a foreign market? (cont.) –  Jan 14 '21 at 16:21
  • @base64 And if the higher interest rate in the domestic currency is an indication that the currency is expected to depreciate (as Mike Scott mentioned earlier), then that's even better for the South African investor. When they liquidate their assets in the foreign market and convert the proceeds, they will get even more rands for their Australian Dollars, US Dollars, Euros, or whatever combination of currencies he'd be dealing with. –  Jan 14 '21 at 16:25
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    Does this answer your question? How can I invest in country A to take advantage of their great interest rate while I live in country B? – nanoman Feb 08 '22 at 23:22

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The difference in interest rates largely reflects the market’s view of future currency movements. Someone wants a higher interest rate to lend to you in ZAR precisely because they expect those rand to be worth less when you repay the loan. So trying to find the cheapest currency in which to borrow is simply another way of trying to beat the market, which is a mug’s game. Just borrow in the currency that you expect to be actually using to repay the loan, which reduces your risk of having to repay more than you thought.

Mike Scott
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  • I think you misunderstood what I meant by "cheapest currency". What I meant was "currency with the lowest interest rate". Whatever moves the ZAR does up or down, is not of importance to the investor in South Africa because they won't have any exposure to the ZAR. That is, they hopefully used the proceeds of the loan to buy securities; not convert the AUD to ZAR and let the cash sit around doing nothing. Right? –  Jan 13 '21 at 21:52
  • @AxiomaticNexus But you were asking why the South African wouldn’t switch their loan to a different currency with a lower interest rate, and the answer is because they will need more rands to repay the loan if it’s in a different currency that appreciates against the rand during the term of the loan. – Mike Scott Jan 14 '21 at 07:52
  • which would only be a problem if you convert the Australian Dollars into rands and stashed the rands under your bed; as opposed to investing the proceeds (still in Australian Dollars, or rands, or any currency for that matter) into appreciating assets. –  Jan 14 '21 at 13:55
  • I must say this answer does not really seem to address the question (which is trivially answered - "the last sentence in the question is quite wrong") and may have some confusing aspects. For me the first sentence is just plain wrong; it may be true in some cases (and different academics would argue about the issue anyway). – Fattie Jan 14 '21 at 15:16
  • Axio, to add confusion - you mention "appreciating assets". Things like houses that "appreciate", appreciate up or down like a cute little white fluffy lamb. But currencies move up and down like a velociraptor on cocaine, it's just a totally different scale. Much much MUCH more violent than - say - if you took all the money and bet professionally on sports. – Fattie Jan 14 '21 at 15:19
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over the long term, unless there is a catastrophe in one of the currencies, shouldn't these fluctutions even out?

No, because the inflation rates in different countries are not random. Germans prefer hard money, and always get it through their tight monetary and fiscal policies. Argentinians, the opposite.

Or, if you like, there are structural reasons why developing countries have higher inflation rates than do developed countries.

These stable differences in inflation do not balance out, thus the currency fluctuations will not balance out, either. E.g. the Mexican peso will mostly weaken against the Canadian dollar for the foreseeable future, just as it has in the past.

An astonishing exception happens when a developing country achieves full developed status. E.g. Japanese yen strengthened against the US Dollar by a factor of 3 between the '70s and the '80s. But East Asia is an exception: The average developing country will never become fully developed.

Orange Coast- reinstate Monica
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  • In the South African investor case, this is an argument for having them take out debt in a strong foreign currency at the lower rate, not against. –  Feb 09 '22 at 18:04
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If I were in South Africa, why would I ever take out a margin loan in ZAR when I could have it in AUD at a much lower interest rate?

The answer is trivial: as the exchange rate changes one way or the other, that difference will absolutely crush (one way or the other) the almost-irrelevant interest rate.

It's exactly like asking "Why can't I drive my Ferrari after two bottles of scotch?" Try it.

Thus, the basic answer to this question is:

but over the long term, unless there is a catastrophe in one of the currencies, shouldn't these fluctuations even out

Yes that's completely, utterly, totally wrong - unfortunately! :)

It is utterly wrong on two different levels:

(1) Your loan is not over that sort of long-term

(2) Currencies indeed notably do not straighten out over long terms; very much unlike say a commodity (which basically "always cost the same forever"), currencies famously and notably suffer drastic macro-historic shifts

Do note though that what you say is indeed done all the time. Japanese housewives had a habit of doing this in certain decades. Huge financial institutions do it as a matter of course (when they lose billions, they simply get a bailout). People who live in really internationalish places with a real-estate focus (HK, MC etc) do this. Folks who live internationally do this. (I have done it a couple times FWIW, it feels like holding a razor at your throat 24/7 for a couple of years.)

So you're not wrong at all - it's just incredibly risky. INCREDIBLY risky. Screw up and the price of your house just doubled or tripled. Not good.

One way to look at it...

Note that all you are really saying in such gambles is "you are good at guessing currencies and you are going to trade that guess (with a massive amount of money, the price of a house)".

Let's say some currency is trading at "0.7". Let us say God, who can see through time, told you would again be trading at 0.7 in say ten years on Tuesday afternoon.

Note that the assumption in the final sentence of the question is indeed just that.

In that case, you could make billions easily.

Unfortunately (this is point 2 above) it's as impossible to make that guess, as is is to make any guess in trading.

And again unfortunately, point 1 gets you anyway. Loans need to be paid out in "a few years", and currencies move violently, they're hoes.

Fattie
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  • I believe a differential of 7% in interest rates is not "almost-irrelevant". I can not predict currency fluctuations, it can go in my favor or against me (that's what I mean by "even out"), but I CAN get a guaranteed 7% savings in interest rates. If the ZAR depreciates, that's great news. If it appreciates by the time I liquidate the assets, then hopefully it won't have had appreciated so much that it nullifies the 7% in interest savings I gathered over the years. That is the logic I'm using. –  Jan 14 '21 at 16:40
  • And if interest rates are that high for the ZAR, the expectation is that it won't appreciate that much, if at all. Is that correct? –  Jan 14 '21 at 16:48