Investment Articles

06/25/02 - The Dollar Slide

By: Frank Armstrong, CFP, AIF

With all the juicy scandals this month, the steep fall of the dollar has hardly percolated off the financial pages into the public's attention. Granted, it's not as much fun as watching Martha Stewart twist and turn slowly, slowly in the wind for alleged insider trading. But, it's far more important in the greater scheme of things.

Nobody sets the value of the dollar anymore. That went out in the 70's with the abandonment of the gold standard. Instead, millions of investors individually decide what they think a dollar should be worth, and a collective judgment on it prevails in capital markets just like any other commodity or capital asset.

During the 90's the world's investors bought into the idea that the US was the safest, most profitable market in the world. So, many of them decided to hold their liquid reserves in dollars, and to buy into our stock and bond markets. This drove up the value of the greenback and helped keep our interest rates low while propelling our stock prices to perhaps irrational levels. All this is quite helpful to an economy that can't quite discipline itself to live within its means. Foreigners underwrote an enormous expansion of our capital markets and soaked up tons of debt that otherwise might have been much more difficult to peddle. US investors (corporate, institutional and personal) found the cost of foreign assets attractive, and tourists packed up for cheap European vacations.

On the other hand, if you were an exporter, your life became more difficult with strong dollars. You had to be even more efficient to hold your own against lower cost foreign competitors. US tourist destinations suffered as foreigners decided that they were too expensive. On a local level Miami Beach (SoBe to those in the know) was reclaimed from the hordes of German working class tourists that had invaded during the 80's. Want to know if the dollar is strong? Just listen for the accents on South Beach.

All that came to a screeching halt last month. Post 9/11 concerns coupled with accounting and financial market scandal and dismal three year returns finally impacted the dollar. The Euro which had been as low as .88 to a dollar just a few months ago is almost at parity today.  The world hasn't given up on the US or the dollar, but they are hedging their bets. Frankly, few economists are surprised. Perhaps it's more accurate to say that they wondered why the dollar remained so strong so long.

You haven't felt the impact yet, but everything you own denominated in dollars isn't quite as valuable as it used to be. Buying those foreign cars and vacations will cost more. On the other hand, your foreign holdings provide a good hedge against the falling dollar. As the dollar falls, they become more valuable.

The only real concern is that if the dollar continues its slide unabated, US capital markets could suffer. We depend heavily on foreigners to buy our debt and equities to support our wasteful ways. Raising interest rates will help prop up the dollar but at the expense of cutting short our economic recovery. So regulators will have to walk the economic  tightrope to get it right. That's why Greenspan gets paid the big bucks!

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