Don't Let Dollar Double-Talk Deceive You

by Dan Caplinger - November 20, 2009 - 0 comments

Never before have foreign exchange concerns been more at the forefront of public awareness than they are right now. If you're not terribly familiar with how currencies work, however, the conflicting rhetoric you're hearing might make you feel more confused than a diehard baseball fan watching an international cricket match for the first time.

Conflicting stories
During his trip to China this week, President Obama urged the Chinese government to allow its currency, the yuan, to rise against the U.S. dollar. While most foreign currencies float freely against the dollar and have risen sharply in value over the past year, China has maintained a peg to the dollar for over a year. The president wants that peg to end, allowing the yuan to appreciate against the dollar.

On the other hand, at virtually every opportunity, government officials trumpet the importance of keeping the dollar strong. Just last week, Treasury Secretary Timothy Geithner reassured Japanese leaders that maintaining a strong dollar was "very important" for the U.S. economy going forward.

So let's get this straight. A strong dollar is important, but we want to make the dollar weaker against the country that many believe will be our primary economic rival in the 21st century. No wonder everyone's confused.

A tug of war where nobody pulls
Perhaps the most confusing part of the foreign exchange market, though, is that a stronger currency doesn't always mean good things for the country that has it. Just look at Japan, for instance. The Japanese yen has appreciated by more than a third against the dollar just since mid-2007. Yet the movement has only made life more difficult for exporters. Analysts expect Toyota (NYSE: TM) to post a loss for the fiscal year. Sony (NYSE: SNE) has lost money in each of the past three quarters, and observers expect it will do so in the next two quarters as well.

Countries that allow their currencies to fall gain a competitive advantage for their exports. That's part of the reason for the president's non-pegged yuan message; a stronger yuan would encourage China to look to develop its domestic economy more quickly, rather than relying on exports to generate its huge growth rates. It would also make U.S. goods more attractively priced, which could help mainstream U.S. exporters join in on what cultural icons like Yum! Brands (NYSE: YUM), Nike (NYSE: NKE), and McDonald's (NYSE: MCD) are already doing: getting into the booming Chinese economy in a big way.

The price you pay
Unfortunately, there's a flip side to the export story. A weaker currency makes it more expensive for people to buy imported goods. Nowhere has this been more obvious than with oil; although ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) posted record profits during last year's oil boom, U.S. consumers felt the pinch at exactly the wrong time, exacerbating the problems that helped to create the financial crisis.

From an economist's perspective, a weaker dollar would theoretically reduce the huge trade imbalance that the U.S. has. Yet for things like oil, where demand stays relatively constant even when prices move dramatically, a weaker dollar can actually have a negative impact on trade deficits, at least in the short run. As long as consumers have to import certain necessities, a weaker dollar may do more harm than good.

Dealing with the dissonance
The question of whether you should prefer a stronger or weaker dollar depends a lot on your own individual circumstances. Those who use a lot of imported goods or invest in foreign businesses that rely on exports to the U.S. would prefer a stronger dollar, to keep costs down and reap profits from investments. On the other hand, if you have mostly domestic stocks in your portfolio, a weaker dollar might support your investments, even as it makes any imported goods you need more expensive.

In any event, you should get used to the seemingly inconsistent messages you hear from policymakers about the dollar. The tension between trying to maintain confidence in the U.S. economy at a time when the nation desperately needs the support of the international community, versus wanting to give U.S. businesses a leg up against their global competitors, forces government officials to walk a fine line that often sounds like complete nonsense. From an investing standpoint, your best move may be to diversify your holdings across the globe -- if only to ensure that you're not overly vulnerable to the fate of any one country's economy.

Last edited by harsheeb on Fri, 11/20/2009 - 11:43 | Write to author: Dan Caplinger |