These New Highs Should Scare You to Death

When an exchange-traded fund hits a new high, it's usually cause for celebration. But the only people who are happy about what these ETFs are doing are the investors who own shares in them. For everyone else, the trend that these ETFs are showing could have devastating effects on their pocketbooks for years to come.

With progress on resolving the debate over the debt ceiling having reached an impasse yesterday, many are increasingly concerned about whether the U.S. will lose its perception of creditworthiness among the world economic community. One market has already made its vote of no-confidence on that question, and ignoring that statement could imperil your entire portfolio.

How currency ETFs are making investors rich
Over the past several months, the battle to the bottom between the U.S. and the European Union has seen the dollar and the euro jostle back and forth like a closely matched tug-of-war. When the sovereign debt crisis in Greece and elsewhere threatens to expand into a bigger deal, euro investors run away from the common currency. But when Europe calms down -- or problems in the U.S. heat up -- suddenly the euro is everyone's favorite currency again, and the dollar takes a tumble.

But as two of the biggest currencies in the world do their dance, investors following other currencies have found a way to make big profits. Several other currencies have made convincing moves to yearly highs:

  • The Japanese yen broke out to near all-time highs against the dollar, with the U.S. currency fetching less than 80 yen. The ironic thing is that Japan has one of the highest debt-to-GDP ratios on the planet, but that isn't stopping investors from seeking yen-tracking investment CurrencyShares Japanese Yen (NYSE: FXY  ) to take advantage of the move.
  • The Australian and Canadian dollars, tracked by CurrencyShares Australian Dollar (NYSE: FXA  ) and CurrencyShares Canadian Dollar (NYSE: FXC  ) , respectively, have moved to 52-week highs on the strength of gold and other commodities. With Australia and Canada both rich in resources, their currencies tend to trade in line with energy and metals prices.
  • Perhaps most importantly, the Swiss franc has been setting records all year as Europeans see the neutral currency as a way to avoid exposure to both the U.S. and the European Union. A franc fetches close to $1.25 now, whereas the dollar and franc were roughly equal in value earlier this year. Investors in CurrencyShares Swiss Franc (NYSE: FXF  ) have seen equally impressive gains.

Why worry?
Foreign currency fluctuations may seem important only if you're traveling outside the country. But increasingly, currency movements can have a big effect on your personal finances.

First of all, a falling dollar puts pressure on the prices of imported goods. So if you buy anything imported, you'll eventually end up paying more for it. With minor fluctuations, importing companies typically try to avoid hiking prices for a while, but narrowing margins eventually force their hands.

Second, a falling dollar creates losses for foreign investors who buy U.S. stocks and other assets. A Swiss investor obviously won't want to buy U.S. Treasury bills at 0.05% if the dollar falls 25% against the franc. Investor appetite for U.S. investments hasn't dried up yet, but if the U.S. can't (or won't) defend its currency, then it's just a matter of time before the rest of the world loses confidence.

How to protect yourself
On the other hand, a falling currency helps some investments. Along with currency ETFs, U.S. multinationals with significant foreign revenue get a boost from a weaker dollar. Philip Morris International (NYSE: PM  ) got a huge boost from favorable currency effects in its most recent quarter. Similarly, both tech giant IBM (NYSE: IBM  ) and snack and drink maker PepsiCo (NYSE: PEP  ) can thank a weak dollar for part of their growth.

The big challenge, though, is that for most Americans, your biggest asset -- the human capital that you turn into a paycheck -- is denominated in dollars. So even as wages have remained relatively stagnant during the recession, the real purchasing power of those dollars has fallen compared to foreign currencies. You might not see all the effects yet, but eventually, the global economy will bring them home to roost.

So as you see currency ETFs reach new highs, don't celebrate. Shareholders may be getting rich, but if the trend doesn't stop, the cost to the U.S. economy could be far greater.

Want some good ETF choices beyond currencies? The Motley Fool's special free report "3 ETFs Set to Soar During the Recovery" has good funds worth a closer look.

One of Fool contributor Dan Caplinger's best investments has been the foreign currency he brought home from Australia and New Zealand last year. You can follow him on Twitter here. He doesn't own shares of the companies mentioned. The Motley Fool owns shares of IBM, Philip Morris International, and PepsiCo. Motley Fool newsletter services have recommended buying shares of Philip Morris International and PepsiCo, as well as creating a diagonal call position on PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy travels the world for you.


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