You've likely heard of this scenario mentioned in an ominous financial forecast: The U.S. dollar continues to lose value compared to other major world currencies, and any number of very bad things occur, spelling doom for our fragile economic recovery.
But even though a low dollar world has a few deleterious side effects, it also brings benefits, and the latter can be profited on by investors who think ahead about where to place their assets. Today we'll discuss what makes the USD rise and fall, and where to position your investments to take advantage of a low dollar world.
The U.S. Dollar Index is an exchange-traded instrument that measures the value of the USD against a basket of 6 major world currencies, including the Euro, Yen, British Pound and Canadian Dollar.
In the past six months, the U.S. Dollar Index has fallen by roughly 13%. This is a continuation of a longer term trend that has seen USD Index fall by 46% since 2001.
What Causes a Falling Dollar?
There is no single bullet theory as to why the USD has fallen, but most professionals point to several ongoing events. First, the strength of the USD is largely determined by how willing global investors are to hold investments denominated in dollars versus other currencies. The USD is often noted as the "world's reserve currency," meaning that foreign governments around the world often choose to park a good chunk of their reserves in dollar assets like Treasury Bonds rather than holding them in their home currency.
But if investors become skittish about the strength of the
Another reason why the dollar has weakened this decade is because interest rates have been historically very low. The 10-year Treasury Bond, a benchmark for global fixed income investors, has seen its lowest yields this decade since the 1960's. These low yields aren't much of an incentive for global investors to buy
The Federal Reserve has had good reason to keep interest rates low; it was crucial in freeing up money flows in the face of a global recession. But as the economy stabilizes, look for the Fed to slowly begin to ratcheting up interest rates. As this happens, the U.S. dollar should begin to strengthen. What Investments to Hold in a Low-Dollar World?
Commodities and other "hard" assets tend to do very well in a low dollar environment. The reason is twofold; hard assets are a safe haven when fiat currencies weaken, and most global commodities are priced in dollars. So foreign investors (whose currency has risen in value vs. the USD), can buy more with the same amount of money. This increases overall demand, leading to rising prices for things like gold, silver and oil. (For further reading, check out How to Invest in Commodities.)
Companies that are based in the
Investors can easily find out how much business a
The future strength of the dollar will largely depend on how well the
And when it comes to the dollar, a little inflation can be a good thing. As our economy strengthens, some inflation should begin creeping back into the system. This will trigger the Fed to start raising interest rates, boosting the dollar along with Treasury yields. When this trend begins to occur, look to shift away from the investments outlined above.
A low dollar world will have some bad side effects, like more expensive overseas travel and higher prices of imports like gas and electronics. But savvy investors can make up the pennies being squeezed elsewhere by profiting from the many companies and assets that are taking a low dollar environment all the way to the bank.