The Dollar Is Doomed

What to make of the recent suggestion by China's central bank that the U.S. dollar should be replaced by a new reserve currency?

Two words: fat chance
It's an intriguing idea -- details on that in just a bit -- but a funny thing happened shortly thereafter. When Treasury Secretary Tim Geithner seemed to momentarily countenance the notion late last month, the dollar swooned, dipping dramatically before Geithner walked his "reasonable, it's-worth-considering" response all the way back to the currency-traders' happy place. Additional reassurance later in the day also comforted the dollar market.

All told, despite the fact that implementing such a move could doom the dollar, the stock market rose throughout all this back and forth … and back. Shares of companies that rely heavily on foreign suppliers such as Wal-Mart (NYSE: WMT  ) and Home Depot (NYSE: HD  ) posted decent gains on the day. Shares of more export-oriented companies like, Dow Chemical (NYSE: DOW  ) , Weyerhaeuser (NYSE: WY  ) , and PepsiCo (NYSE: PEP  ) also did very well. That's telling, I think, with the market (in part) performing weak-dollar math and pricing in the likelihood that these companies' goods could become more attractive abroad.

How's that again?
Currency arithmetic seems -- and in some respects is -- exotic. Still, the basic principle behind the dynamic sketched above is straightforward. Let's say there's a 1:1 relationship between the U.S. dollar and, um, the Freedonian groucho. If a U.S. exporter wants to sell a $100 item into the Freedonian market, the purchaser there will have to pony up 100 grouchos to seal the deal.

If, however, the dollar slips and becomes worth, say, just $0.90 relative to the groucho, that's effectively a 10% price cut.

You can see how this would work in reverse, of course, with the products we import becoming more expensive as the dollar grows weaker. And also of course, we are (and have been) on an importing bender, with 2008's trade deficit -- a figure that sums the dollar difference between the goods and services we purchase from abroad and those we sell overseas -- weighing in at a fat and unhappy $680 billion.

Which, of course, is why the dollar is doomed.

Doomed, I tell you!
Despite an impressive bear-market rally over the last six weeks or so, almost nothing fundamental has changed about our big economic picture. Unemployment remains around 8.5%, consumer confidence, personal income, and spending remain moribund, contributing to what is becoming a bout of deflation. Business spending is also comatose, and after showing some promise, retail sales have recently disappointed, coming in well below the market's expectations last week.

A sagging economy, combined with massive recovery spending and a large trade deficit is likely to weigh on the dollar.

That's not necessarily a bad thing ...
A weaker dollar would make U.S. goods more attractive both at home and abroad, benefiting domestic companies with significant overseas business such as Procter & Gamble (NYSE: PG  ) and Apple (Nasdaq: AAPL  ) .

Combined with the government's outsized spending plan, such a move would pack a one-two punch to pull us out of this looming deflationary spiral and lead, eventually, to a virtuous cycle: increased spending begets increased production, which begets increased job creation, which allows for more spending, leading to increased production, which leads to ...

Well, you get the picture
You can bet the authorities tasked with repairing this economy are aware of these dynamics. China's artificial low-yuan-strong-dollar policy has been criticized for years for wreaking havoc on our trade deficit, and the administration recently backed off on its prior criticism, in part because China has finally allowed the dollar to depreciate.

And savvy investors should be on the lookout for signs that perhaps the secretary's gaffe wasn't a gaffe at all -- but a gambit. It might have been a subtle rhetorical move in a currency chess game that -- for both political and practical reasons -- can't be played with the kind of transparency Geithner's boss generally favors. 

To be sure, there are clear risks to a weak-dollar strategy. It would make imports less attractive, and it could artificially prop up industries that don't deserve the support. A weaker dollar could eventually lead to higher prices as well, since more dollars would be required to buy the same amount of goods.

Those are risks well worth running, though, at least temporarily.

Make your move
No matter which way the dollar or the coded currency conversation heads, investors can profit by devising a portfolio strategy generally well-insulated from shocks to the dollar, while making modest-size moves in the direction policy seems to dictate.

So even if, unlike me, you don't suspect that a weaker dollar will be accepted as part of the government's overall stimulus plan, the latest recommendation of the Fool's flagship Stock Advisor service should appear at the top of your watch list. It's a well-heeled brand name that is insulated whichever way the dollar goes. Its business is currency -- literally -- and the company is poised to profit from both its domestic and international operations.

If you'd like to sneak a completely free peek at the investment case for this market-beater -- not to mention all the others that have helped Stock Advisor beat the S&P by 37 percentage points since its 2002 debut -- click here for a free guest pass. There's no obligation to stick around if you find it's not for you.

Shannon Zimmerman runs point on the Fool's Duke Street and Ready Made Millionaire services. Home Depot and Wal-Mart are Inside Value recommendations. Pepsi and Procter & Gamble are Income Investor picks. Apple is a Stock Advisor pick. The Fool owns shares of Procter & Gamble. You can check out the Fool's strict disclosure policy right here.


Read/Post Comments (7) | Recommend This Article (30)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 20, 2009, at 3:51 PM, madmilker wrote:

    the dang US dollar is fine....the damn Banks are the ones tat are doomed...cause in jus a few weeks Congress is gonna find tat pair of ba!!s and put the Federal Reserve with a little help ($450 million) out of their misery....jus ask Thomas D. Schauf.

  • Report this Comment On April 20, 2009, at 5:23 PM, RickGTOC wrote:

    Hate to comment about spelling rather than content, but Procter & Gamble is the name of the company whose stock symbol is PG. It wouldn't bother me if it were some obscure startup with an odd, invented-by-committee name, but P&G is a major company with a 162 year history. If you can reference it, you can spell it. You're not the only offender; I'm just an equal opportunity nitpicker on this one.

  • Report this Comment On April 20, 2009, at 5:24 PM, rostaffo wrote:

    You have it wrong with P&G! What they sell over seas they make overseas. They do move some products over our two borders, but generally they try to manufacture locally (its cheaper, and more PC).

  • Report this Comment On April 20, 2009, at 7:53 PM, laogao wrote:

    Cool! Nice to have FOREX explained to me by the FOOLS. Didn't know about the Groucho (please capitalise in future....), but will be looking for that 10% pop you predicted.

    Seriously, though, look at the dollar action against the Euro last week - clear end-of-rally sign. DJIA rallied, but USD up also, time to short short short.

  • Report this Comment On April 20, 2009, at 10:29 PM, cindyandron wrote:

    Gee this is not new in history it's happened before just not to us. We brought this on ourselves. I hate it but it is the truth. We need to go back to basics.

  • Report this Comment On April 21, 2009, at 10:24 AM, SintUniversal wrote:

    I don't want readers to get the impression I am anti American. I have 3 sons, all university educated in USA, Case Western Reserve, Williams College and University of Michigan. Our family have many great American friends. rostaffo is correct. P&G, J&J, Big Macs and french fries are made here. Profit of course go to the companies but the jobs are created here. American import almost everything and pay back by T-bills. A currency is strong due to many factors, military, international politics, GDP and social behaviors. It is a known fact USA do not have the military might anymore and the scenario is fast changing because US politicians pay little care for their top brass. Bush administration sidelined Secretary of US Army, General Eric (Japanese surname which I forget) when he warned US would need huge peace keeping force post Iraq war. How can you adore almost naked Hollywood and entertainment stars who wear no underwear and obviously exposed their private parts to the media when they get in and out from the limousines. Tiger Woods probably is not the highest paid athlete but perhaps the most well known world wide. His income from price money and endorsements are higher then many Wall Street CEOs. Tiger is a good guy but there are some sportsmen who cheat, use drug and have character flaws. In time of war, I don't think sportsmen can do better than us because courage is more important than brute arrogance. If USA do not reform socially and comprehensively, the down fall of the once mighty America begin NOW. It is too early to judge President Obama but I think he is good person at least. But a good leader without public and social support just won't work. It is really the duty of every American to be patriotic and restore the Nation back to its splendor.

  • Report this Comment On April 21, 2009, at 12:45 PM, JustAnObserver wrote:

    Hmm, a couple fundamentals:

    1. You can't print money without devaluing it unless your economy is growing at the same rate.

    2. The US economy is not growing at the rate the government is printing money right now.

    3. The only caveat to #1 is that if other governents are ALSO printing money at the same rate you may stay on parity with those currencies (but not with real assets).

    4. #3 indicates devaluation of $USD against currencies that are better managed and against things like oil.

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