If You Think the Dollar Is Doomed, Read This

Warren Buffett has been called a sage, an oracle, and a genius. So when he says something as startling as the following, your ears should perk up: "In the future, I would predict that the U.S. dollar will decline. ... Force-feeding the rest of the world $2 billion a day is inconsistent with a stable dollar."

This is scary stuff. Except one thing: Buffett made that statement at the beginning of 2008, before (1) the U.S. dollar went on to have a pretty good year versus most other currencies, (2) the U.S. government announced the $800 billion bailout and $789 billion stimulus that will force-feed the world billions of additional dollars of U.S. debt, and (3) China's central government proposed replacing the U.S. dollar as the world's reserve currency.

Passing on the buck
Now, we're not policy wonks, Ph.D. economists, or long-winded talk-radio hosts, so we'll leave the politics aside and focus on the implications for your bank account instead. By adding to our massive federal deficit, the TARP and the American Recovery and Reinvestment Act of 2009 could have a devastating effect on the dollar ... a side effect that should scare the dickens out of you.

Similar to inflation, a declining dollar acts like a time bomb in your portfolio. When the dollar is weak, goods purchased from foreign countries -- like, you know, almost everything we buy -- become more expensive.

The good news is that we haven't seen this yet. After last year's volatility, investors around the globe got spooked and flocked en masse to the safety and stability of Uncle Sam. Thus, the dollar strengthened and American investors who owned dollars fared quite well relative to Americans who were invested abroad, despite the fact that many foreign markets had returns better than our own as measured in their local currencies. Take a look:

Returns based on Dow Jones Global Indexes. Source: The Wall Street Journal.

A couple of conclusions
You got hit hard no matter where you invested last year, but you were hit particularly hard if you'd used your dollars to buy stakes in companies that earned Chilean pesos, Canadian dollars, or Brazilian reals.

Now, we know this may be abstract, but it's important. Even more important is the realization that while the dollar had a pretty good 2008, it won't always be this way. When the current calamity subsides, the same investors who bought the dollar this year for its "safety" will remember that:

1. The United States has a massive and growing deficit.
2. The United States continues to generate significant trade deficits.
3. The United States has become oh-so-willing to print money out of thin air to meet its obligations.

When that happens, the tables will turn ... and investors who use their strong dollars today to buy stocks that earn Chilean pesos, Canadian dollars, and Brazilian reals will be rewarded as those currencies strengthen against the dollar in the future. Smart investors like the aforementioned Warren Buffett see this coming, and they're taking one step -- a simple step you can take yourself -- to protect themselves.

Get ready for action
In fact, Buffett has been doing this for years: simply purchasing shares of businesses that do significant and/or growing amounts of business in other currencies. Current holdings UPS and Procter & Gamble (NYSE:PG) are a few examples.

As Buffett wrote in his 2005 letter to shareholders, "We ... purchas[e] equities whose prices are denominated in a variety of foreign currencies and that earn a large part of their profits internationally."

Combine this currency diversification with businesses offering superior returns on capital, and you've got a very compelling addition to your portfolio. The simplest ways you can do this are to look for companies that generate a substantial amount of their sales outside the United States, or to look for companies headquartered abroad:

Data from Capital IQ, a division of Standard & Poor's.

Your next move
Putting aside policies and politics, you needn't be a George Soros-like currency trader to see that the dollar may be in for a rough patch. Instead of being caught off guard, you'd do well to think about positioning your portfolio now. Regarding buying equities with substantial sales in foreign currencies, Buffett wrote that "Charlie [Munger] and I prefer this method of acquiring non-dollar exposure."

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This article was originally published on March 25, 2009. It has been updated.

In four years of writing columns together, this is the first time Tim Hanson and Brian Richards have used the phrase "scare the dickens out of you." Neither Tim nor Brian own shares of any company mentioned. The Fool owns shares of Procter & Gamble. Wal-Mart is an Inside Value recommendation. Diageo is an Income Investor selection. Shanda, Net 1 UEPS, and Baidu.com are Rule Breakers picks. The Fool has a very stable disclosure policy.