In the coming months I expect to hear both hollow and concerned rhetoric in the next few months from politicians about the value of the U.S. Dollar and its decline vs. other currencies in the world.

Why do I expect this?

• From the Minutes of the May 7 U.S. Federal Reserve meeting:  “The members recognized nonetheless that there were upward pressures on costs in a number of areas. These included significant increases in energy costs in recent months, evidence of an upturn in some industrial prices, sharp increases in many insurance costs, continuing upward pressures on medical costs, and modest recent declines in the foreign exchange value of the dollar. With the stance of monetary policy currently quite accommodative, the members saw the need for careful monitoring of the potential for rising inflation pressures as the economic recovery gained momentum.”

• The United States is a nation that imports tons of oil and has a huge trade deficit.  Therefore, a falling dollar means that it takes more U.S. dollars to purchase goods from outside the United States, if the selling parties are denominating their product in another currency such as the Euro.  This could potentially lead to inflation, as the Federal Reserve noted above. 

 Source: www.PrudentBear.com

Many countries have been content to “recycle” the dollars we have paid to them into U.S. securities…As they pull their dollars out stock prices have begun to fall.  The media has not focused on this element to a good extent.  To put it into perspective, take a look at the below charts.  

Source: www.PrudentBear.com

Source: www.PrudentBear.com

• Foreigner's own over 30% of U.S. government bonds and over 10% of U.S. equities.  As the U.S. dollar falls it hurts their bond returns and stock market returns.  Look at it this way.  Say I am a Japanese investor and I invested in the U.S. stock market.  When I invested the ratio of Yen / dollars was 135.  That means that it took 135 yen to purchase one U.S. dollar.  However, as of today (July 12, 2002) the value of the Yen is 116 / 1.  This means that, if I sell my stocks I will only get 116 Yen for each dollar but when I purchased stocks it cost me 135 Yen. If the value of the stock remained flat (0% return) I effectively lost 14% due to currency impacts.  Since the U.S. dollar is falling against most industrialized currencies (the Euro too) foreigners are taking their capital out and investing elsewhere.  Not only are foreigners' investment returns getting hurt by a weakening U.S. dollar the stock market is doing horribly again this year.  For my brief thoughts about the stock market click here. 

• Since the US purchases nearly 20% of the world’s exports, it is essential to stem further declines in the dollar’s value so as to save global trade and the global economy.

• The U.S. Dollar accounts for approximately 68% of the FX armory of industrialized nations’ central banks, compared to 14% for the euro.  In saying this, the U.S. dollar is widely regarded as the world’s reserve currency.  Therefore industrialized nations are concerned with the value of the U.S. Dollar.  They don’t want to see their asset falling by 20% in a few months, let alone 30% – 40%.

• There are two big reasons why Japanese authorities are concerned:

  1. Japanese exports are becoming more expensive in the U.S.    If they don’t increase the price of the products on store shelves profits for Japanese companies will erode. 

  2. Japan has been experiencing a stagnant economy for the last 10 years.  During that time unemployment has doubled from 2% to over 5%.  While that number seems rather low, when comparing it to other industrialized nations such as Germany (10% unemployment) and the U.S. (5% - 6%) many people outside of Japan tend to understand the Japanese culture and their belief in lifetime employment for employees.  Such practices are slowly eroding in Japan but governments throughout the world hold no trump card over the Japanese because they are a net investor in the rest of the world.  When you owe no one money they have very few methods of affecting domestic economic policies.  If Japanese exports fall, due to a weakening U.S. economy and higher product costs, their economy will likely be hurt further.

I hope everyone finds the facts/insights presented in this article valuable.  If you find them interesting please send me a comment @ dan@betterbizbooks.com and forward the article onto as many friends as you want to.  If you want to receive further articles such as this click on the subscribe button on the right to sign up for my Free Monthly Newsletter.

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