It is not news that the US dollar has been shrinking considerably against most major currencies, most notably the Euro and the Japanese yen. If we are looking at US wealth relative to other countries in the world, and relative to imported goods, particularly oil, this has had a significant impact. For example, if the USD has lost 5% versus the euro, and oil today is priced at $82, we can say that the relative price differential of oil is over $4 a barrel in the course of one year. (Granted, the Europeans have for years been paying a fortune for gasoline, but a big part of that price is higher taxes). By the way, the US dollar index has fallen more than 5% in the last 12 months.
What does that mean for investors? That's hard to answer, but let's look at some major points.
1. Companies who have a large portion of their revenues outside of the U.S. will derive higher earnings, at least when they are 'repatriated' and denominated in USD. Earnings accrue in the foreign currency and translate into more dollars when that currency is more highly valued than the dollar. Also goods produced here can be sold cheaper to foreign customers and so market share can increase.
2. As just mentioned, imported goods cost more because it takes more dollars to buy same amount of foreign goods produced by a country whose currency is more valued. This has a ripple effect because many products produced here contain foreign parts or materials. The US auto market comes to mind right away. In short, a weaker dollar can be inflationary, and a rapidly declining dollar can be hyper-inflationary. This was not such an issue fifty years ago when almost everything produced and purchased in the USA came from the USA, but today, with global trade, and with the demand for materials coming from China, the US economy is far more vulnerable than it has been before.
3. Let's temper #3 with this: a large number of companies based in the USA are Multinational Corporations such as Exxon, GE, Pepsi, Intel, etc. So, if we own these types of companies, in addition to having some exposure to foreign stocks, the increased earnings from currency translation of earnings ought to make up for at least a portion of the inflation.
4. There is quite a bit of discussion about a USD crash. Certainly, the US federal debt and deficit spending are the biggest reason. Add to this the problems currently in the housing market and you've got trouble. The fear is that if there is an economic slowdown combined with inflation (yes, stagflation), the percentage of tax revenues used to pay interest on the federal debt will climb. The second part to this scary story is that if foreign investors dump their US debt holdings in response to the declining USD and falling bond prices, the interest the US pays on its debt will rise significantly as our maturing debt is renewed at the newer, higher interest rates. In other words, the interest payments will be rising at the same time tax revenues will be falling.
5. The Fed, by cutting borrowing costs, has essentially made a Hobson's choice between stimulating growth versus stimulating inflation. They made the right choice. By increasing GDP albeit by inflationary means, we are inflating our way out of debt via a decline in the dollar. Simply put, interest on the debt is paid in 'nominal dollars' (except for inflation protected bonds, that is). This approach assures that the percentage of tax revenues used to pay interest on the debt will decline since tax revenues are likely to increase at a faster rate. The decline in the dollar will "transfer" a lot of the pain to foreign debt holders. However, recently many foreign Governments (such as China) have started diversifying out of the dollar, so it would be less damaging to other countries if they eventually abandon US debt. This is a concern.
6. In short, diversify into assets other than just USD-based.
What does that mean for investors? That's hard to answer, but let's look at some major points.
1. Companies who have a large portion of their revenues outside of the U.S. will derive higher earnings, at least when they are 'repatriated' and denominated in USD. Earnings accrue in the foreign currency and translate into more dollars when that currency is more highly valued than the dollar. Also goods produced here can be sold cheaper to foreign customers and so market share can increase.
2. As just mentioned, imported goods cost more because it takes more dollars to buy same amount of foreign goods produced by a country whose currency is more valued. This has a ripple effect because many products produced here contain foreign parts or materials. The US auto market comes to mind right away. In short, a weaker dollar can be inflationary, and a rapidly declining dollar can be hyper-inflationary. This was not such an issue fifty years ago when almost everything produced and purchased in the USA came from the USA, but today, with global trade, and with the demand for materials coming from China, the US economy is far more vulnerable than it has been before.
3. Let's temper #3 with this: a large number of companies based in the USA are Multinational Corporations such as Exxon, GE, Pepsi, Intel, etc. So, if we own these types of companies, in addition to having some exposure to foreign stocks, the increased earnings from currency translation of earnings ought to make up for at least a portion of the inflation.
4. There is quite a bit of discussion about a USD crash. Certainly, the US federal debt and deficit spending are the biggest reason. Add to this the problems currently in the housing market and you've got trouble. The fear is that if there is an economic slowdown combined with inflation (yes, stagflation), the percentage of tax revenues used to pay interest on the federal debt will climb. The second part to this scary story is that if foreign investors dump their US debt holdings in response to the declining USD and falling bond prices, the interest the US pays on its debt will rise significantly as our maturing debt is renewed at the newer, higher interest rates. In other words, the interest payments will be rising at the same time tax revenues will be falling.
5. The Fed, by cutting borrowing costs, has essentially made a Hobson's choice between stimulating growth versus stimulating inflation. They made the right choice. By increasing GDP albeit by inflationary means, we are inflating our way out of debt via a decline in the dollar. Simply put, interest on the debt is paid in 'nominal dollars' (except for inflation protected bonds, that is). This approach assures that the percentage of tax revenues used to pay interest on the debt will decline since tax revenues are likely to increase at a faster rate. The decline in the dollar will "transfer" a lot of the pain to foreign debt holders. However, recently many foreign Governments (such as China) have started diversifying out of the dollar, so it would be less damaging to other countries if they eventually abandon US debt. This is a concern.
6. In short, diversify into assets other than just USD-based.
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