The Good, the Bad, and the Dollar

On her popular Facebook page, Sarah Palin used the weakening dollar as evidence of our urgent need to "drill, baby, drill." U.K. newspaper The Independent wrote an article called "The Demise of the Dollar," and earlier this month, The Wall Street Journal ran a piece titled "World Tries to Buck Up Dollar." Even at the Fool, we've had several articles with dire headlines regarding doom for the dollar.

Yet today, like a cool breeze wandering on by, The Wall Street Journal reported that "the dollar advanced ... on a broad move away from riskier assets."

Phew. Lord knows we wouldn't want a "weak" dollar. One thing we hate as Americans is the perception that we're weak, so a tumbling currency would just be the pits.

Going, going, gone
Sarcasm aside, let's get used to the fact that, yes, the dollar is falling in value. In fact, last week, the dollar sagged to a 15-month low against a basket of major currencies. And according to analysts, the outlook for the dollar in 2010 doesn't seem to be much better. Let's check out why the dollar's going to keep freefalling.

1. On Nov. 4, the Federal Reserve announced that the target federal funds rate will be set at 0%-0.25% for "an extended period." With interest rates that low, foreign investors will continue borrowing in the U.S. and investing abroad, where they can obtain higher returns. Additional investment abroad pushes up the currencies of foreign markets and thus keeps the value of the dollar down. Until interest rates rise, which doesn't seem likely to occur any time soon, investors will continue investing elsewhere, and the dollar will keep sinking downward.

2. Emerging markets have recovered from the financial collapse much more quickly than most of the developed world has, including the U.S. While some domestic stocks, such as Apple (Nasdaq: AAPL  ) and Amazon (Nasdaq: AMZN  ) , have seen impressive returns, the emerging market has seen winners such as Vale (NYSE: VALE  ) , Petroleo Brasilerio (NYSE: PBR  ) , and China Fire & Security (Nasdaq: CFSG  ) . For a broader sense of the emerging market's rapid recovery. Look at the return of these indices in comparison with the S&P 500.

 

Return Since Dec. 31, 2008

Return +/- S&P 500

China (SSEB)

101.9%

80.3%

India (BSE)

74.7%

53.1%

Brazil

76.9%

55.3%

Taiwan (TWI)

67%

45.4%

The rapid influx of capital into emerging markets such as China, India, and Brazil will push up their currencies, as asset prices tend to increase over time. In addition, the increasing ease of entering these markets through popular ETFs such as iShares MSCI Brazil Index (NYSE: EWZ  ) should also keep money flowing in. Combined, these factors will also keep the dollar down.

3. Foreign countries can buy dollars and hoard foreign exchange reserves to keep their currencies down against the dollar; however, many countries have already done this with limited success. And in light of the recent financial collapse triggered in part by the U.S. subprime crisis, most foreign governments are hesitant to stockpile dollars. This will help keep foreign currencies up against the dollar.

What this means for the U.S.
Economist and author Paul Krugman has said that "although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable." George Soros agrees. And so does Warren Buffett. I'm no expert, but those guys certainly know a thing or two.

A weak dollar helps U.S. exporters by making their goods more globally competitive. Companies such as Intel (Nasdaq: INTC  ) will be sending more processors abroad, while others, such as Procter & Gamble, see a boost in household-product sales. For the 10% of you who are unemployed, the hope is that domestic production increases enough to put a dent in that disparaging 1-in-10 number.

In addition, a weak dollar will help us reign in the enormous trade deficit we've been carrying for years. Although there are certainly varying viewpoints on the pros and cons of our trade imbalance, it can hardly be argued that borrowing less abroad to fund consumption at home can be a bad thing. Any sort of deleveraging is a good sign, considering the recent financial collapse.

One thing we can be sure of
Despite calls for the replacement of the dollar as the world's reserve currency (a discussion that's been going on for years), the American greenback isn't going anywhere anytime soon. Of the world's official foreign exchange reserves, 64% are in dollar-denominated assets. Second to the dollar is the euro, lagging substantially at about 27%. Replacing that sort of dominance isn't something that can happen overnight. Almost all standardized commodities are valued in dollars, and invoicing in one currency helps all parties involved in a contract. Additionally, the size, sophistication, and relative stability of the American financial system keeps transaction costs down for international trade -- there just aren't any other currencies that can offer what the dollar can. As Treasury Secretary Timothy Geithner recently said: "I think the dollar remains the world's dominant reserve currency. I think that's likely to continue for a long period of time."

Am I way off, or does a declining dollar sound all right by you? And does anyone think the dollar should be replaced by some sort of global currency? Fools -- weigh in!

Jordan DiPietro doesn't own shares in any of the companies mentioned above. Apple and Amazon.com are Motley Fool Stock Advisor picks. Intel is an Inside Value pick. Petroleo Brasileiro and Procter & Gamble are Motley Fool Income Investor selections. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. Check out the Fool's strict disclosure policy.


Read/Post Comments (21) | Recommend This Article (44)

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 November 18, 2009, at 5:29 PM, thisislabor wrote:

    uh.... no it doesn't sound ok.

    it sounds like creating one problem to fix another.

  • Report this Comment On November 18, 2009, at 6:52 PM, ironyworks wrote:

    It's devaluing our time spent working and increasing our costs for anything here that the rest of the world wants, both at home and abroad.

    Inflation has all the disadvantages of a flat tax..IW

  • Report this Comment On November 18, 2009, at 7:21 PM, WDC1 wrote:

    No, it doesn't sound too good to me either unless we're

    attempting to make a shift in our economy--in which case maybe we should talk about it.

    We have an internal "consumer" economy that does not rely heavily on exports.

    Cheap dollar means more expensive imports. Buy American! In theory (and in the distant future) could mean more jobs. Of course, it might also mean the next time I need a car my butt might be condemned to a Chrysler.

    It's such a complicated issue, and just because it's good for Warren and Tim probably indicates we suckers should brace ourselves.

  • Report this Comment On November 18, 2009, at 7:25 PM, motelytom wrote:

    The decline in the value of any currency is what happens in a market system when a country runs a big and prolonged deficit in its balance of trade. That decline is what brings adjustment in the flow of goods and services - as in any market. It seems that some folks want the U.S. to have a "strong dollar" as a symbol of national strength. It isn't. Its the strength of the economy that matters. Also, we need to save more and import less - especially fewer imported consumption goods. Also, higher import prices will stimulate import substitution production in the U.S., hopefully including new forms of energy. Jobs will be created in both export industries and import substitution industries, to the benefit of many. Let's get over this nostalgic longing for a higher dollar.

  • Report this Comment On November 18, 2009, at 8:02 PM, Cuprock wrote:

    I'm new to this stuff. And I have a question. In paragraph 5 the above states; "With interest rates that low, foreign investors will continue borrowing in the U.S. and investing abroad, where they can obtain higher returns."

    My question is, "How can I, a US citizen, invent abroad and take advantage of this too."

    Thanks

  • Report this Comment On November 18, 2009, at 8:19 PM, shortsided wrote:

    I don't think we should be overly concerned with swelling the coffers of Mr. Buffett, or esp. Mr. Soros...the tsar of currency traders. When our Presidents-elect are sworn into office, little more is asked of them but that they "...preserve, protect and defend the Constitution of the United States." Is it too much to ask of our Fed Chairmen and Treasury Secretarys that they preserve, protect and defend the currency?

  • Report this Comment On November 18, 2009, at 9:23 PM, xetn wrote:

    If we were still a huge exporting country, a weak dollar would indeed be desirable. But we are, and have been for some time, a net importer. So, being a net importer means that a weak dollar is adding costs to the consumer. This is essentially the same concept of the Fed inflating the money supply, which will result in reduced purchasing power. (Do you see any connection here?) Or how about part of the huge run up in dollar denominated gold? Or how about the imposition of tariffs on Chinese tires? Exactly how does that aid the consumer? It does not aid the consumer, only the unions making domestic tires at a non-competitive price. (Sounds like Obama's partial pay-back for the Union's support during the election as well as his 35% gift in GM's ownership).

  • Report this Comment On November 18, 2009, at 9:24 PM, gvc40 wrote:

    The dollar's value is directly proportional to the competence of the congress and president to make wise financial decisions. Surprisingly, BIll Clinton and the Newt Gingrich Republicans can claim the high ground. They made the tough choices either to increase taxes or spending cuts to bring a balance budget and resulting high dollar value. I would favor the latter, but giving world markets confidence in your long term credit worthiness drives long term $$ value. George Bush and the Rep Congress managed to spend like drunken sailors and the dollar dropped. Go fugure!! Some MBA from Yale?? NO guts to make tough choices and pay for wars, etc. The problem is the political system rewards reps who complain about everything high taxes, low services, too much government or not enough, rathar that the middle ground. That is no mans land where candidates get killed. China may not be remotely democratic, but they get things done. When we wake up in 20 yrs and they have blown by us, we will wonder where all the leaders were years ago that could have prevented this.

  • Report this Comment On November 18, 2009, at 9:43 PM, mansfieldanne wrote:

    Messrs Krugman, Buffett and Soros. Says it all, really.

    Be very afraid of the decline in the dollar. Autarky never did any country any favors.

  • Report this Comment On November 18, 2009, at 11:40 PM, PsycheDaddy wrote:

    Will they devalue the dollar like they did in 1934?

    That's maybe the last tool they have. It brought the economy back after everyone devalued.

  • Report this Comment On November 19, 2009, at 12:00 AM, robertf36009 wrote:

    Soros has destroyed currencies before while betting against them to enrich himself just look at the British pound. Now he has gone after the biggest game of all the U.S. dollar.

  • Report this Comment On November 19, 2009, at 12:29 AM, jomueller1 wrote:

    Personally, I do not like any currency to go up or down. That would not be realistic because of greedy speculators and incompetent politicians manipulating the markets.

    As much as I like to whine or let my sarcasm out of the cage the question is what to do about the dollar weakness. The big guys will not give a hint because that would eat into their profits. So we little guys have to hunt for breadcrumbs. I look for them in other countries and in commodities. My worry is only that I get my umbrella open quickly when it starts raining.

  • Report this Comment On November 19, 2009, at 1:25 AM, ET69 wrote:

    Supposedly as the dollar drops our exports get cheaper and therefore we export more....Problem is we don't have much of anything TO EXPORT anymore...our industrial base is nearly toast!

  • Report this Comment On November 19, 2009, at 4:18 AM, Divonner wrote:

    I think a weak dollar for a period of time should be seen as a good thing. Many US companies export abroad. Intel and Apple have huge non US markets. As they swell their dollar earnings because their goods are cheap overseas and snapped up, the value of their stocks increase. Currency exchange rates vary hugely over time. As the US economy stabilises and as some international US companies make huge dollar earnings, the pendulum will swing back to a strong dollar. Long to medium term - that sounds good to me and now is the time to stay focussed and hold steady on US companies who are poised to make large gains by virtue of the weak dollar.

  • Report this Comment On November 19, 2009, at 4:41 AM, rajeshjohn wrote:

    i wish the currencies stop jumping around so much as it upsets all planning,

    America has in the past 8 years have made stupid stupid investments in Iraq and Afganisthan. Iraq was a lousy investment and so was Afganisthan.

    America messed it up by trying to give contracts to American Business - who mostly did a shoddy job and tax payers paid for it. But there was no ROI.

    Today afg and Iraq are messed up - with no good going to come of it because of excess greed.

    Had you bombed afganisthan and pulled out leaving the norther alliance in power and with outside support - the country would still be messed up - but you would have had your revenge.But no - you had to have your business contracts to be given out to freinds of bush.

    Had you dumped Iraq on the UN and pulled out as in kosovo - the place would be messy - but 4000 soldiers would be alive and billions not squandered. Iraq should not have touched in the first place. Instead of quick footing out of the place - you stuck around awarding orders to halliburton - who took tax payer money and proceeded to move address to Dubai. Now you have an independant minded govt in Iraq, and the Iraquis are naturally resentful of the huge numbers youve murdered - they are not particularly favourable to American Business.

    With such ROI its not surprising the US dollar is expected to tank. What with the economic crisis on top of it, and your printing paper money in trillions

    I pray for you, as my own future rides with you.

    .

  • Report this Comment On November 19, 2009, at 5:37 AM, CarryOnAgain wrote:

    I think Krugman has managed to contradict himself in a single sentence when he says "although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable."

    So the dollar is falling then. Ok, then the doomsayers have it right. A country cannot continue to import more goods than it exports for ever - that much should be commonsense. So far, the US has managed to acheive this my printing IOU's to the Japanese and Chinese to fund their profligate consumption. But now, these countries are getting rather nervous - apparently the value of these IOU's might not be all they seem. Well there's a suprise.

    So what happens to Americans if the dollar really declines? The import of inflation and a consequent reduction of imports until they balance exports, which will obviously increase as the dollar weakens. Bottom line, the purchasing power of US citizens will decline as their dollar devalues. Eventually, a balance will be restored, and US manufacturing should pick up to fill the expanding exports. So in that respect, Krugman is correct about the desirability of a dollar decline.

  • Report this Comment On November 19, 2009, at 11:32 AM, matthewbanis wrote:

    so yeah, the US dosn't export anything...anything Intel is selling abroad is made abroad - we're screwed. Buy gold, silver, foreign currencies, agriculture, other commodoties.

    Impeach Obama.

  • Report this Comment On November 19, 2009, at 3:25 PM, enginear wrote:

    When Chinese workers work for $10/day, and we work for ... (put the number from your locale here), something has to give eventually.

    Bad choices by our leaders? yes, and some good ones too, but we can't compete in that market forever.

    Do we expect things to remain such that we drive cars 40 miles to work from our homes (they would call them country estates) in the surrounding areas, Take our trailers/boats off to a vacation spot each weekend while everyone else in the world lives in what we consider a closet, ride buses to work, and look at owning one small television as a luxury?

    The falling dollar is part of the rebalancing that the markets do for us while we don't even notice usually. It is a bit painful to watch, but with the yuan pegged to the dollar still, much of our Wal-Mart purchase price will remain the same (will it come unpegged if/when the dollar rises?).

    Basically it is healthy, and don't believe our industrial base is 'toast'. Caterpillar, Eaton, Parker Hannafin, GE, United Technologies,... the list goes on. We will buy more from our own sources (and generally, I think our products are better), so don't despair, the end is NOT nigh.

    Things will change, but one of our best strengths in The good old U. S. of A. is the ability to adapt. We'll do fine over the long haul. Buffet,Soros, Krugman knowi it, and they are putting money on it too.

  • Report this Comment On November 19, 2009, at 4:57 PM, TFNOON wrote:

    "The Dollar" is a piece of paper. Period. It is only worth what someone else will trade for it.... something with true intrinsic value.

    When a government can issue debt (a "currency") or print money on other pieces of paper at will with no conscience or trepidation..... then the other holders of other pieces of paper soon realize that their paper (or "accounts" monetized in dollars) is worthless. They will resist realizing this too suddenly. It is like glass. All glass is, whether we can see it or not, flowing downward. It will take a while for the glass to become too thin to hold out the wind or to resist the push of a human hand....but it will....even though we cannot see the process. Eventually, people will realize. Older savers will realize that Uncle Sam has diluted their savings at a rate of 5-10-15% per year while they were "earning" 1-2% in interest in CDs. They were being robbed in slow motion. Like the flow of glass........

  • Report this Comment On November 19, 2009, at 10:34 PM, robertf36009 wrote:

    Soros has destroyed currencies before while betting against them to enrich himself just look at the British pound. Now he has gone after the biggest game of all the U.S. dollar.

  • Report this Comment On November 20, 2009, at 9:31 AM, sofpan wrote:

    Gold is the answer for declining dollar in people's comprehension.

    Economists say that Gold is not anymore a currency.

    But for peoples comprehension gold is currency.

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