With the recent political turmoil facing Egypt, Libya and Bahrain, both media and investor attention has been focused on the Middle East. However, as the world watches the region, many domestic problems are becoming back-page news. Over the last few years during the global credit crunch, the U.S. dollar rose as its "safe-haven" status was affirmed. Nonetheless, the dollar is facing some major long-term headwinds. Monetary inflation caused by rounds of quantitative easing, coupled with exploding federal, municipal and private sector debt have some analysts calling for the death of the greenback. While the complete collapse of the currency is a matter of debate, the long-term trend does point downward. Luckily for investors, there are plenty of options for protecting their portfolios from this trend. (For background reading, check out Quantitative Easing: What's In A Name?)
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A Downward Trend
The dollar index, which measures the greenback against a basket of six currencies, fell to 76.756 last week, the lowest point since early November. So far, the dollar has lost nearly 2.7% since the beginning of 2011, dropping 1.1% in February alone. This is helping reaffirm the long-term downward trend. Since its peaks in 2001 until 2008, when the global recession began, the U.S. Dollar Index fell nearly 40% over that time frame. More recently, the political turmoil in the Middle East has driven traders to other safe-haven currencies like the Swiss Franc (NYSE:FXF) and has supported various currencies that benefit from higher energy prices.
The rest of the globe is also raising questions about whether the global financial system would be better off with an alternative world reserve currency. Recently both China and the International Monetary Fund have contended that special drawing rights (SDRs) could help stabilize the currency system. These financial securities are based on exchange rates determined by a fixed basket of international currencies and give their holders the ability to accept repayment in whatever currency they choose. The IMF is also prepared to issue government bonds denominated in SDRs, allowing many central banks to bypass U.S. Treasuries.
In addition, the emerging market superstars known as the BRIC countries have been working on reducing their dependence on the U.S. dollar. China and Russia have agreed to use each other's currencies for international trade between the two nations and the People's Bank of China has started to set up bilateral currency swap lines with various nations, such as Argentina and South Korea, in order to facilitate Chinese yuan-based trade.
Adding Protection to Your Portfolio
With the dollar facing a long-term downtrend, it makes sense for investors to add some protection to their portfolios to prevent currency losses and pending inflation. The good news is that there is a plethora of new options and ways for investors to gain that insurance. For example, the PowerShares DB US Dollar Index Bearish (NYSE:UDN) makes a single bet that the dollar will fall against a basket of currencies. But there are other ways to play the dollar's fall.
Buying foreign currencies used to be a risky thing for retail investors. Now with the proliferation of ETFs, buying currency can be as easy as buying a stock. By focusing on stronger currencies, investors can profit as the dollar falls. Commodity-based currencies such as the Australian dollar (NYSE:FXA) and Canadian Loonie (NYSE:FXC) have prospered in recent years. The WisdomTree Dreyfus Commodity Currency (NYSE:CCX) follows a basket of eight different currencies from commodity-rich nations such as Norway and charges 0.55% in expenses. In addition, investors can get currency exposure by owning bonds in foreign currencies. The Market Vectors EM Local Currency Bond ETF (NYSE:EMLC) and SPDR Barclays Capital International Treasury Bond (NYSE:BWX) track a variety of non-dollar denominated bonds.
Commodities continue to be a great way to play dollar uncertainty and rising inflation. Even though prices have skyrocketed over the last year, both the PowerShares DB Commodity Index Tracking (NYSE:DBC) and Market Vectors RVE Hard Assets Producers ETF (NYSE:HAP) make good long-term options for adding commodities.
Finally, domestic large caps that receive the bulk of their revenues from international sources will benefit as those currencies are translated back into dollars. The Consumer Staples Select Sector SPDR (NYSE:XLP) tracks some of the largest domestic multinationals that will profit from the growing emerging middle classes of the developing world.
The Bottom Line
With ballooning public and private debt and the expansion of the money supply, the world is losing faith in the dollar. The dollar's long-term decline is something investors should take seriously. Luckily, there are plenty of ways to help protect a portfolio. The ETFs presented here are an ideal solutions to fighting this problem. (For more, check out ETFs: How Did We Live Without Them?)
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