INVESTING: Long slide of U.S. dollar has many repercussions

November 19, 2007

Few economic topics get more complicated than those about the U.S. dollar. The interrelated causes, effects and ramifications of changes in the value of the U.S dollar can make anyone's head swim.

Because the dollar has been the "reserve currency" for the world-the currency held in store by foreign central banks and used to settle economic trade in things like oil-the prolonged slide in the dollar's value is of concern to many around the world. For example, the greenback has fallen 44 percent against the euro since 2002, and recently hit a 33-year low against the Canadian dollar, known as the loonie. The loonie, which traded as low as 62 cents to the U.S. dollar in 2002, is now valued at about $1.05 per U.S. dollar.

Other commodity-based economies have seen their currency strengthen vs. the dollar, including Australia and Brazil. Warren Buffett recently commented that it is unsettling that Brazil now is helping prop up the U.S. dollar with its purchases of U.S. government securities. He noted that "Brazil is a country whose own currency has gone to nil five times in the past century."

There also is unease over whether foreign holders will "sell" dollars and move into other currencies, or whether they might buy up U.S. assets that have become cheap because of the dollar's decline. It has been estimated that, over the next five years, "sovereign wealth funds" may shift $6 trillion out of dollar-denominated U.S. Treasury securities and into equities, non-government debt and other investments.

Sovereign wealth funds are state-sponsored investment funds that have accumulated dollars primarily from global trade. China has a $200 billion sovereign fund invested in U.S. Treasury securities, but has begun to shift into other investments such as its $3 billion investment into the Blackstone Group, a U.S. private equity company. Australian investors have been active acquirers of infrastructure assets as witnessed by the Chicago Skyway and Indiana toll road deals.

In its contradictory role, a strong currency can cause its own problems. For example, the rising value of Canada's currency has caused a groundswell of Canadians' traveling to the United States to buy things cheaper. Canadian retailers are realizing they must cut prices to stem the loss in sales, then try to negotiate lower prices with their suppliers.

Our government continually has stated that it is in our best interest to have a strong dollar. Yet in fighting that battle, the Federal Reserve has its hands tied. Higher interest rates would help stem the dollar's decline. Yet raising rates could send our weakening economy into recession. Reducing our trade deficit would help the dollar. Yet American consumers show no trend toward less consumption and more savings.

In the end, our standard of living will advance at a slower pace if the dollar continues its relentless decline vs. other world currencies. Investors may be able to counter this trend by investing in companies that earn profits outside the United States.

Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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