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Tickers in this Article: DB, AVN, UDN, UUP
Trading currencies is risky business; there's no doubt about it. For most, the risk of trading Forex is just too much, as the leverage factor can quickly wipe out accounts. However, investors can play currencies through exchange-traded funds (ETFs), taking out a some of the risk in the process, but it's important to remember that even with an ETF, picking the direction of a currency is tough stuff. (To learn more, check out Forex Leverage: A Double-Edged Sword.)

Before we get too far, though, let's take a moment to examine the present global economic environment.

Global GDP Falling
On Wednesday, April 8, the International Monetary Fund released the 2008 April World Economic Outlook. Within the document, there are a few shocking items. First, the IMF predicts 2008 U.S. GDP growth will decline to 0.5% in 2008 and 0.6% in 2009. What's more, the IMF also predicts the entire global GDP environment will decline to 3.7%, and is projected to remain broadly unchanged in 2009. (To find out what the IMF does and why it is so controversial, read What is The International Monetary Fund?.)

At first glance, the news seems dismal for the U.S. However, something else is happening within the report too. Over the past few years, the euro has been amazingly strong and is still trading just below all-time highs. This strength has created an inflationary environment in the Eurozone, while subprime issues overseas are threatening an economic slowdown. The European Central Bank has its hands tied, as an interest rate cut could kick up inflation. Note: On Thursday, the ECB left rates unchanged at 4.0%, while the BOE cut the Main Refi Rate by 25 basis points to 5.00%.

However, in the IMF's report, the organization actually recommends the ECB consider "easing of the policy stance", in order to keep liquidity abundant. Amazingly, the aforementioned alludes to a potentially stronger dollar in the year to come. At the end of the day, a reversal could appear, but nothing is set in stone.

Currency ETFs for Average Investors
In 2007, Deutsche Bank (NYSE:DB) and Amvescap, now called Invesco (NYSE:IVZ), launched two exchange-traded funds that allow investors to either take a bullish or bearish position in the U.S. dollar. The ETFs put the U.S. dollar against six major currencies: the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc. (Learn to take advantage of these vehicles in How To Use ETFs In Your Portfolio.)

Specifically, the ETFs are:

  • PowerShares DB U.S. Dollar Bullish Fund (AMEX:UUP)
  • PowerShares DB U.S. Dollar Bearish Fund (NYSE:UDN).

Investors who believe the dollar will rise win with the Dollar Bullish Fund, while those who believe there's more downside to come, will profit with the bearish fund.

It's important to note that both funds have relatively high expense ratios of 0.55, however, much of the cash paid into the funds is also invested in fixed-income securities. To clear the air, the Treasury yield income offsets the expense ratio, but does not include any gains/losses from the actual currency moves.

Under the Hood
Breaking down the "basket of currencies" within the funds, it's important to note that the U.S. dollar index is tracked virtually the same way. In 1973, when Nixon agreed to let the dollar float freely, the New York Board of Trade created the U.S. dollar Index (USDX) to help track the greenback against global currencies. The Index is benchmarked on the base value of 100. The USDX is trading at around 72, meaning that measured to the world's main currencies; the dollar is trading 28% below where it was in 1973. Shocking, I know. Within the index, the foreign currencies are weighted as:

Currency Units per U.S. dollar for the USDX
Currency Weighting
Euro 57.6%
Japanese yen 13.6%
Pound sterling 11.9%
Canadian dollar 9.1%
Swedish krona 4.2%
Swiss franc 3.6%

As you can see, movement of the U.S. dollar against the euro will have the greatest effect on the U.S. dollar index, something investors in the aforementioned ETF's will want to keep in mind. (To learn more about how to profit when currencies move against each other, read Common Questions About Currency Trading.)

Final Word From The IMF
"With the [U.S.] dollar now close to its historic low in real effective terms, is the adjustment now complete, or perhaps excessive?" the IMF asks on page 38 of its report, concluding, "The current account deficit could narrow more significantly over time, even with the dollar staying near the current low level. During the adjustment phase, however, the still-large deficit would continue to be a potential source of further downward pressure on the dollar."

At the end of the day, if the United States starts paying its bills, expect a stronger greenback. If it can't, we all might want to watch where we're walking, because the trap door could open underfoot.

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