Investment Articles

02/24/04 - Trouble In Dollar Land

By: Frank Armstrong, CFP, AIF

The US Government's massive fiscal stimulus may have perked up our domestic economy a little, but currency traders around the world watched fretfully and voted with their feet. The dollar is falling like a rock.  Just like corn, pork bellies or crude oil, the dollar value is set by free market conditions as millions of traders constantly decide which currency they want to hold. Tax cuts, huge deficits, low interest rates, easy money and abymisal trade imbalances do not inspire confidence that currency will hold its value. In a world where every outstanding dollar must be owned by somebody, supply and demand set the price.

Normally, we would expect a steep fall of the dollar to be inflationary. The items we import should all go up in price. But, with global overcapacity in many products, foreign producers have had to suck it up and reduce their margins in order to stay competitive. Additionally, for historical reasons crude oil, one of our big import items, is priced in dollars. So, we haven't felt the full effects yet. In this respect, Alan Greenspan recently characterized the inflationary impact as "benign".

What impact does a weakening dollar have on an investment portfolio? It could be very negative. Fortunately owning foreign stocks effectively hedges the dollar. For instance, for each percent the dollar falls against the Euro, an investment in any Euro based index increases a percent. So a globally diversified equity portfolio is generally close to currency risk neutral.  If you are an exporter, you are in hog heaven. Everything you sell just got lots cheaper on foreign markets. If you are in the travel business, America is on sale! Lots of foreigners will want to come here to spend their strong currency on our bargain vacations.  But, I experienced severe sticker shock during a quick trip to Paris last fall. That giant sucking sound you heard was my credit card being mercilessly pumped dry! And it has gotten worse since then. It's my own fault.

I should have re-read my article, "Vacation Exchange Rate Arbitrage."  The fundamental lesson of that article is to go where your local currency is strong. So, you may wish to plan this year's vacation in countries with currency linked closely to the dollar. That leaves you the US, all the rest of this hemisphere, the Caribbean, lots of the Pacific and many Asian developing countries. Profit from my foolishness.  This too shall pass. America will muddle through. Currency values fluctuate just like any other commodity. While I am not enthused about our fiscal policy, I wouldn't want to exchange our problems for any other country's problems. The falling dollar is not a precursor to the end of capitalism as we know it.

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