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.

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!