The Dollar Will Rebound

You know the dollar is in a sad state when the previously dollar-hungry Indians won't accept U.S. currency for admission to the Taj Mahal anymore.

The U.S. dollar has suffered a sharp drop over the past five years. Just this week, it sank to fresh lows against the euro and continued to slide against other major foreign currencies, including as the Japanese yen and British pound.

There are many reasons for the decline, including high oil prices, anxious U.S. credit markets, weak relative growth in our gross domestic product, the Chinese yuan issue, and a bulging trade deficit with the rest of the world. Moreover, capital has been flowing abroad in recent years, particularly to emerging-market countries, as investors seek better growth opportunities.

The winners and losers
But the falling dollar isn't all bad news. When the dollar is weak, U.S.-based multinationals such as Johnson & Johnson (NYSE: JNJ  ) , General Motors (NYSE: GM  ) , and Boeing (NYSE: BA  ) have a competitive price advantage over European competitors such as GlaxoSmithKline (NYSE: GSK  ) , BMW, and Airbus. As a result, the European firms may need to lower prices to compete with the American companies in foreign markets. Meanwhile, in the U.S., foreign companies have to charge more in dollars to earn the same amount of their own currency.

In recent years, U.S. luxury retailers such as Tiffany (NYSE: TIF  ) , tourism companies such as Vail Resorts (NYSE: MTN  ) , and consumer-goods firms such as Nike (NYSE: NKE  ) have benefited from the weak dollar. But the good times might not last forever.

They never do ...
It may take some time for the dollar to regain its footing. But at some point, the forces that have pushed the dollar down will reach equilibrium, or even reverse the trend. In fact, based on purchasing-power parity, the euro is roughly 30% overvalued versus the dollar, causing even investing guru Bill Gross to turn bearish on the euro.

Theoretically, such a rebound should stimulate interest in dollar-denominated goods. And although trade barriers, transportation expenses, and inflation affect that process, such large price discrepancies will be difficult to sustain over the long term.

It's all about the Benjamins
It's been only five years since the strong U.S. dollar was causing problems in the international markets. Ironically enough, an October 2002 New York Times article called the dollar "seemingly unsinkable."

The point is that despite all of the adverse factors contributing to the weak U.S. dollar, we shouldn't forget that the currency markets are cyclical. The dollar will be strengthen, then weaken, and then strengthen again, ad infinitum.

That's why it's important to be properly diversified with both domestic and foreign stocks. When the dollar begins its next upswing, international firms that do a lot of business in the U.S., such as Italian furniture maker Natuzzi, will stand to benefit. Having both international and U.S. companies in your portfolio means you can make money regardless of which currency is strong and which is weak.

This article was originally published on November 9, 2007. It has been updated.

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Kristin Graham updated this article, originally written by Todd Wenning, and does not own shares of any company mentioned. Johnson & Johnson and GlaxoSmithKline are Income Investor selections. Vail Resorts is a Motley Fool Hidden Gems choice. BMW is a Stock Advisor recommendation. The Fool's disclosure policy works hard for its money.


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