Level 4-Should a Shrinking Dollar Worry You?, WSJ, by Jason ZweigSep 12, 2009
The dollar is falling. Is the sky falling, too?As of this week, a dollar would buy only 0.68 euro, down from 0.80 in March and a peak of 1.21 in 2000. The greenback slid against other major currencies as well.That may be a problem for investors. If most of your assets are in dollars but much of the goods and services you consume are priced in other currencies -- say you like imported cars or regularly vacation abroad -- your future spending needs have just gotten harder to fund.
Fortunately, it's not that hard to protect against further erosion in the dollar. And not all investors need to take action. Hedging would be vital, quips Campbell Harvey, an economist at Duke University who edits the Journal of Finance, "if your mortgage is denominated in euros." But if you make your money in the U.S. and spend it in the U.S., a falling dollar isn't the end of the world. Thus, the slide in the greenback need not prompt every investor into urgent action, but it is an ideal pretext for asking whether you are globally diversified.
Three cures are most commonly prescribed for investors worried about a weakening dollar: foreign currency, gold or a diversified basket of commodities.Trading foreign currencies like Australian or Canadian dollars, both tied closely to commodity prices, sounds appealing. But foreign-exchange trading usually relies on high margin, or leverage, which is risky, and gains are taxed at hefty rates. So an individual investor has to be really right to rationalize doing it, says Mark Kritzman, who helps oversee more than $25 billion at Windham Capital Management in Cambridge, Mass.As for gold and other commodities, they have provided an average return of around 20% in the four quarters following the worst drops in the value of the dollar, according to Michele Gambera, chief economist at Ibbotson Associates.Surprisingly, these glittering returns look tarnished next to those of stocks and foreign bonds.
On average, based on more than 20 years of returns, Mr. Gambera found that in the four quarters following the steepest declines in the dollar, U.S. stocks go up 25%, various baskets of international bonds gain between 21% and 28%, and non-U.S. stocks go up more than 56%.So, with many commodities near record highs, there may be no need to join the stampede into gold or most other hard assets.If the dollar keeps dropping, stocks and bonds priced in euros, yen, rubles or shekels will tend to become more valuable; anything denominated in foreign currency will then buy more dollars. That's why, for U.S.-based investors, international stocks and bonds tend to outperform commodities when the buck falls. Global diversification thus provides an automatic buffer against a dollar drop, unless the fund managers have hedged the holdings back into U.S. currency.By the same token, big American companies that earn much of their revenues outside the U.S. may do better as the dollar drops; kronor and rupees will then convert into a greater number of greenbacks, putting more profit in U.S. shareholders' pockets.But raising your overseas holdings can make sense even if the dollar stops falling.
U.S. stocks represent less than half of the total value of equities world-wide, and yet American investors keep more than 70% of their stockholdings here at home. Although roughly two-thirds of the world's debt is outside the U.S., American investors have less than 4% of their fixed-income portfolios in foreign bonds.For many years, I've kept half of my stockholdings outside the U.S. The more convinced you are that the dollar will fall, the more you should hold in international stocks, ideally through a low-cost index fund that doesn't hedge currencies. Even if your view on the dollar turns out to be wrong, you will end up with a better diversified portfolio.I don't have any foreign bond funds myself; I was turned off long ago by their risk and illiquidity. But choices are better today. If you are especially worried about Uncle Sam, consider T. Rowe Price International Bond or, if you can avoid the sales charge by going through a discount broker, the Class D shares of Pimco Foreign Bond (Unhedged). SPDR Barclays Capital International Treasury Bond, an exchange-traded fund, is another good choice, but only if you can find a discount broker that won't charge commissions to reinvest your interest income.Over the course of time, currency fluctuations tend to wash out. And even a long-term decline in the dollar might not be disastrous; since 1950, South Africa has had one of the world's weakest currencies, but one of the best-performing stock markets. The dollar is falling, but the sky isn't.
QUESTIONS: 1. (Introductory) By how much percentage did the U.S. dollar fall against the euro since its peak in 2000?2. (Advanced) What options are available to investors to protect them against a weakening dollar?3. (Advanced) How do big American companies with overseas earnings benefit from a falling U.S. dollar?4. (Introductory) Does a weak U.S. necessarily imply it is a bad for U.S. stock markets over the long period of time? Why?
12 comments:
I agree with Zeigsep that it is a good idea to invest in foreign markets if it seems that the dollar is going to fall. However, I do not think it is necessary for people who mostly spend their dollars on U.S. goods to invest in foreign markets. Sure, this will give you a more "diversified portfolio," but the author doesn't really explain the benefit of that for people who don't spend their money on foreign commodities.
I can understand why the author explained that it will become more difficult for those that consume goods and services in other currencies, because I can already see that unfolding in our daily lives. It is a lot more expensive to buy imported goods, or to travel to other countries. I think this will only get worse over time. It also seems like people will have to contain their US dollars in America, as explained by the author in order to maintain in a good financial position.
I disagree with Gillian. People who only purchase U.S. goods should invest in the foreign market since the earnings they recieve back give them more U.S. dollars since the dollar is worth less than the foreign currency, so they can then use their profits to purchase more U.S. goods which will then translate to growth in American businesses and foreign businesses as well (since they invested in them).
I think a diversified portfolio is necessary if one wants to invest. If the dollar is falling and one is only invested in U.S. companies, then the value of their investments could also become unstable. A diversified portfolio permits more stability because if one's economic success is not dependent on only one asset. If one investment is struggling, the other ones can still have the possibility of growth.
It seems logical for one to diversify their investments, however while Zweig says that global diversification provides an "automatic buffer", he does not elaborate on this matter which leaves me a little skeptical. Like Gillian said, if someone only spends and makes their money in the United States, why even bother diversifying? I am sure there are many benefits to keeping a "diversified portfolio", but Zweig does not mention any in the article.
I agree with gillian, that it is good to not invest in only one market, but for the majority of Americans who pay in US dollars and earn US dollars, a falling dollar is not that big of a deal. I think that if Americans just wait it out, and tighten up their budget, that things will pick back up soon.
Because of globalization, the rises and falls of different currencies are less of a problem. Zweig highlights that because of the growing availability of foreign stocks and bonds, U.S. investors can hedge the risk of investing in domestic commodities. I agree with Paige, because just because you're investing in foreign countries doesn't mean that you're shutting out American businesses, who are also invested in those countries.
The dollar shrinking should worry some people. For example, people who travel often to different countries, their dollar is worth less and so they will have to pay more to get the same amount as the last time they went to said country.
I agree that one should diversify their investments to weather the weakening dollar. I also think that diversification in any kind of market will be to the advantage of any investor. I think even with the dollar losing value to the euro, wise investors will switch to stocks and bonds priced in international currency.
Since it is not hard to protect from further erosion in the dollar, i do not think that Americans should be too worried about the shrinking dollar. I agree with the article that it is important to invest in foreign markets, but at the same time Americans just need to keep control of their money and wait this all out
I think the shrinking dollar effects people in different ways. I also agree that it is good to invest into foreign markets because it will increase your purchasing power.
It makes sense for Americans to invest in foreign markets to diversify but, I am not surprised that most Americans only invest in U.S. stock. The value of the dollar is shrinking and people do not know how it is going to affect them. Investing in foreign markets acts as a safety net.
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