What to Do When the Dollar Crashes

Many people were so stunned by the $0.18 rise in gas prices over the past two weeks that they failed to recognize some incredible occurrences in the currency market. The U.S. dollar recently hit:

• A two-year low against the euro.
• A 10-year low against the Australian dollar.
• A nearly 10-year low against the Singapore dollar.
• The next in what seems to be an endless stream of lows against the Chinese yuan.
• A hair's breadth away from crossing $2 for one British pound. 

The dollar's dropped a huge amount in the past several years, against many of the major currencies. Of course, the real time to start worrying about the dollar was six years ago, when it sat at levels 50% higher against the euro. But even after such a significant drop, these days, you'd have a hard time finding someone who was truly bullish on the U.S. dollar.

Why money moves
Economics tells us that currencies rise and fall against one another because of inflation. And of course, the late economist Milton Friedman noted that "inflation is always and everywhere a monetary phenomenon."

So while currencies clearly tend to be beasts of fear and greed, their movements are based on something. Currencies move down when traders believe that the economy in one country will be more inflationary than in others. High inflation, in other words, means a devalued currency. At least, that's the way they draw it up in economics class. Frankly, currency trading doesn't interest me that much. Investing in stocks based on the most likely outcome for currencies, on the other hand, interests me a lot. In my role as advisor for our international investing service, Motley Fool Global Gains, I do this sort of analysis a lot.

The dollar's never-ending drop
You might think that after the dollar has dropped so much that its most likely path would be upward. The International Monetary Fund disagrees. Last Thursday, the IMF warned that further substantial declines in the value of the dollar are needed to bring the American current account deficit -- currently running at 6.5% of GDP -- into balance. There are fixes to this, mainly revolving around raising American savings rates and decreasing government spending, but the most likely path is the further debasement of the dollar. (See Warren Buffett's essay on "Squanderville" for a simple explanation.)

I don't know what's going to happen -- in the words of Albert Einstein, "I never think of the future -- it comes soon enough." But I do spend a great deal of time thinking about things that ought to happen.

The Chipotle (NYSE: CMG) class B shares ought to be priced higher than the A shares, for example. Eventually, they will be. And if the U.S. dollar ought to go down against other currencies, well, eventually it will. That means that as an investor based in the United States, I'd like to increase my exposure to companies that have little to no exposure to the dollar.

Of course, this isn't as easy as simply buying a bunch of international firms.

Buy companies with the right exposure
Let me explain. If you wanted to avoid exposure to the U.S. dollar, you wouldn't want to hedge by putting your money into Indian programming giant Infosys Technologies (Nasdaq: INFY). Infosys is a fine company, but most of its business is written with American firms, and its contracts are valued in U.S. dollars. Investors don't really benefit from exposure to the Indian rupee, because conversion to the rupee takes place only at the last point of a transaction.

You would garner much more protection against a potential dollar decline owning Columbus, Ga.-based Aflac (NYSE: AFL), which does some 75% of its business in Japan, denominated in yen. Aflac is also a better hedge than Finnish telecom giant Nokia (NYSE: NOK).

But what about companies with almost no exposure to the dollar? In Global Gains, I recommended shares in Taiwan-based GigaMedia (Nasdaq: GIGM), a company that provides online entertainment and broadband services to customers based in Asia and Europe. Almost none of the business is conducted in U.S. dollars. Or what about Telefonica (NYSE: TEF), the Spanish telecommunications giant with services in Spain, the U.K., Germany, and Latin America, but minimal presence in the U.S.? Or how about Guangshen Railway (NYSE: GSH), which owns the monopoly on the tracks running between Hong Kong and Guangzhou in China, among the fastest-developing economies in the world?

I know this
One shouldn't necessarily build one's investment portfolio on the basis of economists' prognostications. As a group, their accuracy records make soothsayers look positively prescient in comparison.

But by the same measure, if you're living in the U.S., getting paid in U.S. dollars, and (increasingly) buying goods produced overseas, there's a great deal of benefit to building in some diversity of exposure to other currencies through your investment portfolio. Think of it this way -- if these companies stay absolutely still, and the dollar does continue to drop, you'll still make money.

Bill Mann is the advisor of Motley Fool Global Gains. Today's new issue with two new recommendations releases today at noon ET. You can access the issue when it's released with a 30-day free trial.

Bill Mann owns shares of Chipotle. GigaMedia is a Global Gains recommendation. Chipotle is a Motley Fool Hidden Gems and Rule Breakers recommendation. Aflac is a Stock Advisor pick. The Motley Fool has a disclosure policy.