Three months ago, The Wall Street Journal reported that central banks across the globe were frantically trying to hold their currencies down as the dollar continued its slide. The news was ubiquitous -- the dollar was doomed, and American investors were left wondering whether they were overexposed to international stocks, or whether they should be even more diversified.

Well, things have certainly changed in just a few short months. The fiscal instability of Euro zone countries such as Portugal, Spain, Ireland, and most notably, Greece, has dragged the euro downward. The dollar has surged as investors fled to the perceived safety of the greenback. But do the difficulties in Western Europe really warrant such quick optimism for the dollar?

I don't think so. 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 over a few 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, 2009, 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 sink again.

In addition, emerging markets have recovered from the financial collapse much more quickly than most developed markets. While some individual domestic stocks like Google (Nasdaq: GOOG) and Novavax (Nasdaq: NVAX) brought impressive returns in 2009, emerging-market stocks such as China Agritech (Nasdaq: CAGC) and Telestone Technologies (Nasdaq: TSTC), 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)

 126.7%

104.3%

India (BSE)

77.2%

54.8%

Brazil

124.6%

102.2%

Taiwan (TWI)

67.8%

45.6%

*as of 2/25/10; 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 simple: 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 Philip Morris International (NYSE: PM) and DuPont (NYSE: DD), which earn 100% and 62% of their respective 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 FormFactor (Nasdaq: FORM) -- a California-based company that designs, manufacturers, and sells semiconductor products and solutions. FormFactor earns about 66% of its revenue abroad, and that number has been steadily increasing since 2004. With zero debt and $9 in cash per share, the company is in a great position to take advantage of a semiconductor industry that's only poised to grow even more in the future. Operating everywhere from Germany to Taiwan, it's perfectly placed to benefit from a falling U.S. dollar -- and that's only part of the reason why our Hidden Gems analysts have recommended it five times over!

Our Motley Fool Hidden Gems team is constantly looking for small-cap stocks that are poised to outperform. While significant foreign revenue certainly isn't the only criterion our team looks for in a stock, at least six of the companies in our real-money portfolio -- yes, the Fool puts its money where its mouth is -- have greater than 40% international revenue.

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

Fool contributor Jordan DiPietro doesn't own shares of the companies listed above. Google is a Motley Fool Rule Breakers pick. Philip Morris International is a Motley Fool Global Gains recommendation. FormFactor is a Motley Fool Hidden Gems selection. Motley Fool Options has recommended a bull call spread position on FormFactor. The Fool owns shares of FormFactor. The Fool has a disclosure policy.