Despite the dollar's recent rise, the outlook still remains somewhat grim. Two months ago, The Wall Street Journal reported that central banks across the globe are frantically trying to hold their currencies down as the dollar continued its slide.

The news is ubiquitous -- the dollar is doomed, and America's mighty currency is on a slippery slope downward. In the wake of such pessimistic news, investors are left wondering whether they're overexposed to international stocks, or whether they should be even more diversified.

Before we answer that question, let's take a look at why I think the dollar is going to drop, and how you can best position yourself to take advantage of the fall.

I've fallen and I can't get up
Just three months ago, the dollar sagged to a 15-month low against a basket of major currencies. According to analysts, the outlook for 2010 seems to be just as dreary.

Why?

On Nov. 4, the Federal Reserve announced that the target federal funds rate will be set at 0% to 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 get higher returns. Additional investment abroad pushes up the currencies of foreign markets, thus keeping the value of the dollar down. Until interest rates rise, which doesn't seem likely any time too soon, I think investors will continue investing elsewhere, and the dollar will keep sinking.

In addition, emerging markets have recovered from the financial collapse much more quickly than most developed markets. While some individual domestic stocks like Dow Chemical (NYSE: DOW) and NVIDIA (Nasdaq: NVDA) brought impressive returns in 2009, emerging-market stocks such as Dr. Reddy's Laboratories (NYSE: RDY) and Jinpan International (NYSE: JST), have, as a group, outperformed. Look at the return of these indexes in comparison with the S&P 500:

Region

Return since Dec. 31, 2008

Return +/- S&P 500

China (SSEB)

 122.9%

101.4%

India (BSE)

 79.1%

57.6%

Brazil

125.7%

104.2%

Taiwan (TWI)

69.7%

48.2%

*as of 1/28/10; in $ terms.
Source: The Economist.

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. This will also keep the dollar down.

What's the dollar to do?
Nobel Laureate and author Paul Krugman has said, "Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable." George Soros agrees. 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 competitive, which will inevitably boost domestic production for those companies that don't buy the majority of their raw materials abroad. This will likely stimulate the economy and improve unemployment. A weak dollar will also help us rein in the enormous trade deficit we've been carrying for years.

Although there are definitely varying viewpoints on the pros and cons of our trade deficit, it's certainly better to borrow less from abroad to fund consumption at home. Any sort of deleveraging is a good sign for our economy.

In other words, the question at hand isn't whether or not the dollar will continue to decline, or whether or not that decline is a good thing. The question that matters to you is, how can investors take advantage of the situation?

Lower greenback, higher returns?
Since it looks like developing markets will continue their spectacular rise, you might benefit by investing directly in foreign equities, or multinational companies that generate substantial revenue abroad.

However, there's an even better way to capitalize on the fall of the dollar: Purchase small-cap U.S. companies with international exposure.

While large-caps like Southern Copper(NYSE: PCU) and Freeport-McMoRan (NYSE: FCX), which earn more than 50% of their revenues abroad, should experience nice bumps in sales, small or midsize companies will benefit disproportionately, because increases in exports will have a greater effect on their bottom lines.

To that end, you'll want to look for small- or mid-cap companies with at least 20% of revenue from abroad, and limited debt, so they'll be able take advantage of international expansion.

For instance, check out K-Tron International (Nasdaq: KTII) -- a New Jersey-based company that designs, manufacturers, and sells material components for the industrial sector. K-Tron earns about 30% of its revenue abroad, a number that's been steadily increasing since 2004. The company has averaged a return-on-equity of about 22% over the last three years and has grown both its revenues and earnings by an impressive margin over the last five years. Operating everywhere from Africa to Europe to the Middle East, it's perfectly placed to take advantage of the falling U.S. dollar.

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This article was originally published on December 4, 2009. It has been updated.

Jordan DiPietro doesn't own shares of the companies listed above. NVIDIA is a Motley Fool Stock Advisor pick. Jinpan International is a Motley Fool Hidden Gems recommendation. The Fool owns shares of K-Tron International. The Fool has a disclosure policy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.