Recently, the international insurance industry associations and others have expressed interest in understanding how changes in the local economy might bring about changes in the valuation of the local currency. What does depreciation or devaluation of a currency mean? Let's examine the concept of devaluation by starting with just the opposite. How do you value anything?

Tangibles (physical things) carry their own perceived value: a 200-year old chair, an Old Master's original oil painting, a litre of gas, a pound of Angus strip sirloin, a diamond ring, a gold watch. As the old saying goes, 'beauty is in the eye of the beholder' and the law of supply and demand always determines 'real' market value.

Intangibles, such as stocks and money, have no value on their own. Yes, stocks generally sport a market value (what a willing buyer and seller will exchange consideration for), and paper money has a value assigned to it (printed on it). The real value, though, comes from (derived) the underlying (the adjective becomes a noun in the investment industry). Without the underlying to provide backup value, there is little or no value.

So how is value determined? Stocks are equity holdings in a company. If the company has a strong financial balance sheet; runs a tight ship; has good corporate governance; keeps debt under control; performs consistently in good and bad times; and provides continued growth, its performance inspires confidence plus great creditworthy ratings from independent rating agencies. Corporate credit ratings have been in numerous articles lately since the hurricane disaster clean-up has been assessed. And when immediate action is taken to raise capital, there is a real level of comfort (and economic strength) that management and the board of directors understand their markets, their products, and have a controlled operation plan in place.

The Value of Paper money also derives from the value of the underlying. At one time, money was real; you could bite it to test if its metal was real. Originally when paper money, being more practical, was introduced, it was backed by the gold standard. Now the underlying (value derived) is the fiscal strength of the country and its government. Make no mistake; a country is a business and receives agency ratings just like any other business. When considering the enhanced value derived from a country, the criteria are the much the same: a stable environment, good corporate governance including a system of checks and balances (law enforcement, military), manageable debt (balance of payments), independent oversight and democratisation of processes, public sector transparency, consumer and environmental protection, an excellent legal system, ability to provide for its citizens in social safety net, and wonderfully, if available, natural resources.

Countries that can provide all of the above along with being uniquely situated to reap profits from oil, say, or mineral rich mine deposits have a natural advantage. In a country as small as Bermuda, the only natural resources are far more limited: the beauty of its natural surroundings, the stability of its economy and monetary system, and the good will of its people. Natural or otherwise, to generate hard cash, tangible and intangible resources still have to be marketed and sold to foreign investors (tourist, industry and the like).

Currencies have two classifications: hard currency, usually from a strong industrialised country, is that which everyone has confidence in (because it is a safe haven in times of international tension) and everyone consequently wants, such as US dollars, euros, the British pound, the Japanese yen and the Swiss franc. Soft currencies, on the other hand, generally from less sophisticated, smaller countries, are considered less preferable during times of increased inflation, political or military risk.

Floating helps. The major hard currencies have floated against each other, in sort of a popularity contest, in the largest exchange in the world ? in excess of a trillion dollars ? and at all times are appreciating or depreciating against each value. Currently, the US dollar is tending to depreciate against the pound, the euro, the yen and others, even though the opposite has been true as well over the years, where the US dollar dominated. Those travellers from Europe and the Far East are enjoying their currency strength by laying off lots of risk at the gambling tables in Las Vegas, and other US dollar cheap destinations.

Smaller or less economically powerful countries, in order to provide confidence in their currency, will allow it to float in value (or in some cases peg) with a very stable hard currency. The Chinese renminbi, for instance, is pegged to the US dollar while Panama has no native currency, using the US dollar instead.

What causes a currency to depreciate/appreciate? Perception, rumour, trade deficits, capital outflows, low foreign reserves, economic instability, sound (or unsound) fiscal policies, inability to spend outside home country, favourable (or unrealistic) exchange rates, etc. What is often not realised is that even major currencies at one time or another have been considered structurally unsound ? the pound after the Second World War. Additionally, in a real devaluation, the country (government or central bank) may deliberately devalue a currency to attract foreign investment and thus reduce its balance of payments. The opposite effect of such a calculated strategy is higher local costs of almost everything for the domestic population, along with a black market for hard currency.

How can one plan for currency fluctuations? At least in Bermuda, you have the choice and the chance to diversify. If you were situated in the middle of Ohio, for instance, it would be bit more difficult to find a variety of investments in various currencies for hedging purposes. A simple rule of thumb to consider is this: if you have most of your hard assets represented by one currency, try to diversify away from that concentration of risk by placing your investments in one or two other currencies. If your portfolio is larger, owing a variety of securities in a variety of geographical locations and currencies may fit your confidence profile.

What ever you decide (or not decide) to do, remember that perception is reality when it comes to confidence in the underlying values of currency. And that is why we have rating agencies, such as Moody's, S&P, and AM Best; they provide the real rating numbers.