Protect Yourself From A Falling U.S. Dollar

By Douglas Rice | November 16, 2009 AAA

The U.S. dollar has fallen more than 7% this year and there doesn't seem to be any reason why it would turn around. The Chairman of the Federal Reserve said recently that the dual mandate of lower inflation and higher employment will help the dollar over time, but right now employment isn't getting any better and the Fed is unlikely to reduce the amount in supply any time soon.

Add to that the comments by Dallas Federal Reserve President Richard Fisher, who said that a gradually depreciating dollar doesn't necessarily add an enormous inflation impulse, and one can come to the conclusion that the dollar will continue to weaken for the foreseeable future.

Falling Dollar, Climbing Inflation
Many think that the falling dollar is good for us. It makes our exports less expensive and that will be good for some firms in the United States. And as long as we aren't travelling abroad, it shouldn't matter to us very much. Unfortunately, that thinking is flawed.

We are still an importing nation and much of our goods are produced overseas. While China has pegged its currency to the dollar, so their goods may be stable, other countries goods will rise in price as the dollar falls. That means inflation here in the U.S. and that's not good at all. While most people can't earn a paycheck in a foreign currency, investors do have the option to invest overseas. (Your investments suffer when general price levels rise. Learn how you can control the damage with IPSs in Curbing The Effects Of Inflation).

No one can predict the future with certainty, but if you think the dollar is going to continue to fall relative to other currencies, wouldn't it be wise to invest some money in those other currencies?

Fight Inflation With Forex
Currency trading (forex or FX - short for foreign exchange) is big business. There is over $2 trillion dollars traded each day. But don't confuse size with regulations. The currency markets are basically unregulated with no governing body or clearing house. This means there is no NYSE or Nasdaq to make sure that transactions occur as intended. Because there is little to no oversight, things like insider trading or shorting without an uptick aren't a problem.

Also, because currencies aren't traded on the common exchanges, directly buying or selling them requires a forex account which is separate from your typical brokerage account. But that shouldn't dissuade you from considering it an option. There are reputable forex dealers that would be more than willing to set up any investor that has a few bucks. (We go over the ground rules and available resources needed in Forex: Wading Into The Currency Market.)

What should give you pause is that the size of the typical trading unit is 100,000 units of the currency involved, although some forex dealers will offer mini lots of 10% of that number. Because this is relatively high, the use of margins is essential to be active in the market, and using margins means that gains and losses will be magnified.

For example, it's typical to see 100 to 1 leverage in the currency markets. So for $1,000 an investor can control $100,000 in currency. That means that a small move can provide big profits or big losses. The risks here may go beyond the tolerance of the average investor.

Not For You? Look At ETFs
There are other options beyond jumping into the FX markets directly. There are ETFs that retail investors can buy just like a stock for every major currency. They avoid the need for a separate currency account as they do trade on an exchange. Also, they don't use the leverage that is typical in FX markets.

For those investors that desire involvement but lack the experience, this option can serve as a training ground. (There's always a bull market somewhere - and now you can find it with currency ETFs. Learn how in Profit From Forex With Currency ETFs.)

Another way to get exposure to foreign currency is to buy the ETF of the countries you believe will benefit from a falling dollar. There are ETFs for every major country and exposure to their companies will provide exposure to their currency.

Sticking With Stocks? Go International
But there are other options for investing if you believe in a falling dollar. The most obvious way is to select stocks for your portfolio that do considerable international business. Companies like McDonald's and Coke have significant revenues from overseas and they will profit from the falling dollar. That shouldn't be the only factor in buying them, or any stock, but it is something to consider. Want to gain exposure to foreign markets? Find out what type of international fund might suit your needs in Broadening The Borders Of Your Portfolio.)

An even more specific way to get exposure to a foreign currency is by buying foreign stocks. An individual stock, unlike an ETF which is a basket of stocks from that country, can benefit from not only the overall appreciation of their currency and how well the country does as a whole, but will also rise or fall based on its own success. You can buy most major foreign stocks as ADRs so you can avoid opening a trading account in a foreign market.

The Bottom Line
While these options are less risky than opening an FX account and using 100 to 1 leverage to try to beat the currency traders, all of these options have risk even if the dollar does continue to fall. Consider those risks before you invest.

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