Dodging the falling dollar
With all the attention on Social Security reform and the budget deficit, few people are concerned with the trade deficit. But that may change if the dollar continues its decline.
Our trade deficit is the difference between the value of U.S. exports and its imports. The Commerce Department recently reported that the trade deficit climbed to $58.3 billion in January, the most recent data available. Our appetite for foreign cars, auto parts and consumer goods continues to set records with no end in sight, as consumers shop until they drop.
But there is a downside: In exchange for sending us all this cool stuff, foreign coffers are swollen with dollars. But too much of a good thing may not be so good at all, and now we're finding that many countries are cutting back their dollar holdings.
It comes down to a supply and demand imbalance. Those foreign holders have too many dollars and demand for them is waning. Some countries are actually swapping their dollars for other currencies to diversify their currency holdings -- no individual or country should put all their eggs in one basket.
The dollar has tumbled in recent weeks as government officials in Japan and South Korea suggested that they may consider holding fewer dollars in reserve, while China and India have done more than hint. The Bank for International Settlements, an international group that fosters cooperation among central banks and other agencies to maintain monetary and financial stability, reported that Chinese banks held only 68 percent of their reserves in dollars in September of 2004, compared to 83 percent in the third quarter of 2001. More telling were the moves in India, where dollar holdings tumbled to 43 percent from 68 percent.
As U.S. currency becomes less attractive to hold -- and is even sold by some countries -- its value declines, meaning it will take more dollars to buy those lovely foreign things we crave. Or to use the scary word: inflation, as too much money chases too few goods. Inflation can lead to higher interest rates, which erode the value of bonds.
Not a good thing if you plan to sell them before maturity. Not a good thing if you are depending on income from bonds.
And not a good thing for stocks. If rates rise to fight the inflationary pressures of a falling dollar, business borrowing costs will rise. At some point businesses will decide not to borrow at such high rates, thus limiting business spending and development.
You may think a falling dollar is good for boosting our exports, since they will cost less for other countries to buy. That might have been true when we produced the lion's share of the world's goods, but we are gradually becoming a country that exports ideas that the rest of the world uses to create the things we buy.
Just look at the shelves of your local grocer. The United States used to dominate the export market for food products, but not anymore: In January, we exported $4.74 billion in food while importing $5.55 billion.
There's plenty of blame to go around. You could pick on the high cost of labor. You could blame what some call the onerous regulatory environment of this country.
But you could also look at yourself. The next time you go into Wal-Mart (where 80 percent of the stuff comes from China) or drive that Toyota (granted, many of those are built in Kentucky, West Virginia, Indiana and Texas, to name a few states), know that the profits from those items are going into the coffers in another country.
There are ways to insulate yourself against the falling dollar and the potential pain that may set in. For one, individuals can hold currencies other than dollars. It could be as simple as not cashing in that Euro dollar when you return from traveling overseas or as easy as opening a savings account in a foreign currency. The Wall Street Journal recently reported that one online bank, EverBank World Markets, now offers savings accounts in 20 foreign currencies with a minimum deposit of $2.500. Also available are certificates of deposits in many foreign currencies for a minimum of $10,000, plus a conversion fee of 0.75 percent.
Mutual fund managers have noticed the direction of the U.S. dollar and introduced funds that track its rise and fall, but as always, you must do your homework. Currencies can be a risky investment, and may not be the best investment vehicle for some. But they offer an interesting way to protect your assets in a falling dollar environment.