The Declining Dollar
More Green Stuff e-Letter: Issue #5
December 4, 2006
The Declining Dollar: The Mounting Evidence of Why Your Money’s Melting
by Alexander Green
Oxford Club Investment Director
Last week, Treasury Secretary Henry Paulson repeated his mantra that the U.S. government favors “a strong dollar.” Don’t believe him for a minute. As the economist Ludwig Von Mises famously said, “Government is the only agency which can take a useful commodity like paper, slap some ink on it and make it totally worthless.” “Buy why would they?” some might ask.
In this case, a weaker dollar makes foreign imports more expensive here at home and U.S. exports more competitive overseas. That’s a positive, especially when you’re facing a new Congress with protectionist leanings – and running a trade deficit with more zeroes than Stephen Hawking can comprehend.
Last week, of course, the declining dollar hit a 20-month low against the euro, and a 14-year low against the pound. Now, the dollar bears are really out in force.
The Mounting Evidence for a Declining Dollar
My colleague Kris Sayce in Australia has taken to calling the greenback “the U.S. Peso.” David Gilmore at Foreign Exchange Analytics, a consulting firm, says there is no unified opposition to a lower dollar among foreign governments, creating “a green light for dollar sellers.” And my friend Dan Denning, editor of Strategic Investing, says he is just as certain the dollar will fall as that the sun will rise tomorrow.
That’s confidence. And, let’s face it… many facts are on his side:
- European currencies are strengthened by perceptions that European interest rates are more likely to keep rising. Higher interest rates make a currency more attractive to investors because they provide a higher return. (Governments and big institutions shop currencies for higher rates like you might shop your local banks for the highest-paying CD.)
- Many countries no longer hold only U.S. dollar reserves, but are instead diversifying among a basket of currencies. That keeps selling pressure on the buck.
- There are seasonal factors at work, too. Many foreign investors tend to sell dollars near the end of the year to repatriate profits. Barclays Capital reports that the dollar has fallen against the euro in the first two weeks of December every year since the euro’s birth in 1999.
Predictably, of course, the average investor is now rushing to get in on the action. As the Wall Street Journal reported on Friday: “In the first nine months of this year, international and global funds hauled in $134 billion while U.S. stock funds collected $20 billion.”
This is extraordinary. By a ratio of more than 6-to-1, U.S. investors are shipping their equity money overseas rather than investing it at home. That was certainly a good move four years ago, but is it a sensible strategy today?
For long-term investors, yes. Despite short-term fluctuations, exposure to foreign markets and foreign currencies over the long haul is famous for boosting returns and lowering portfolio volatility. The answer is yes as well, perhaps, for very short-term traders. The trend is clearly their friend.
It’s that medium-term outlook that should bother you. Here’s why.
Let’s start with the average punter pouring money into non-U.S. funds right now. To me, this smacks of performance chasing and nothing more.
Chasing recent hot performance is perhaps the world’s worst investment strategy. It didn’t work with Internet stocks in 1999. It didn’t work with condo flipping in 2005. And it’s not likely to work for dollar bashers today.
What You Should Know About Investing in the Dollar Right Now
Let’s start with one of the most basic premises of investing: Anything everyone knows is not worth knowing.
Perverse as it may sound, if there are a multitude of reasons for the dollar to fall and virtually no reasons for the dollar to rise, that’s generally factored into exchange rates. In other words, don’t expect the dollar to fall next week for the same reasons you cited this week.
Secondly, not everyone applauds a lower dollar. Try booking a trip to Zurich, and you’ll quickly see why. No American likes to see his cash treated like the lira when he’s traveling abroad.
And, perhaps most importantly, remember that a weak dollar cuts the primary source of growth of many nations – namely, exports to the United States. So, expect to see opposition mount as the dollar continues to melt.
My take is this: It’s prudent to hold your long-term investments in individual foreign equities, as well as your international stock and bond funds. But I certainly wouldn’t make big bearish bets on the dollar in the futures or options markets right now (as many hedge funds are doing).
Nor would I plunge headlong into foreign currency-denominated investments at the moment. The water may feel fine, but it may not be terribly deep.
Best Regards,
Alexander Green
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More Green Stuff’s Cribsheet:
- In 2006, the dollar has dropped 6.7% against a Federal Reserve index of seven major currencies.
- Specifically, the dollar has fallen 11% against the euro this year and 3.8% in the past two weeks alone to end at $1.3336 per euro on Dec. 1. This year’s decline against the euro is the biggest since a 16.7% loss in 2003.
- The Wall Street Journal reports, “Europeans are flocking to U.S. stores for Christmas shopping because the dollar’s weakness makes the U.S. look like a bargain basement to them.”
- “Funny how you don’t notice the U.S. dollar tanking until you live outside the U.S. (and are still paid in U.S. dollars).” ~ Colleague Brian York, from our Australian office in Melbourne
Wit’s End
“Always do right. This will gratify some people and astonish the rest. “
~ Mark Twain
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- Trading Currency: How To Easily Play Moves in the Dollar with Three Distinct Investing Choices
- The Decline of the Dollar: Four Torpedoes Headed Straight For the U.S. Dollar… Take Cover and Profit
- Investing in the Currency Market: Why Now Is the Time to Invest in Currency… and How the Shift in the U.S. Dollar Supports this Strategy
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