Case for the Falling Dollar

If I had to pick an investor concern du jour, it would be the hand-wringing over the falling dollar. To hear some talk, “to catch a falling dollar” is more like playing catch the falling knife. Others see it with a little less fear, something along the line of the song “To Catch a Falling Star.”

There is no doubt that the devaluation of a nation’s currency can have serious consequences for its economy and those who invest in stocks and bonds. The “knife,” or “dollar bear,” crowd point to the budgets and trade imbalances as evidence the dollar is about to plunge to unheard of depths, taking our economy and well-being along with it.

Investors are quick to point out that it is only a matter of time before we, as a nation, owe more than 50% of our public debt to foreign bankers, who sooner or later will cash in, causing interest rates to soar – and leaving our economy spiraling down into a recession.

No doubt, the U.S. government does spend hundreds of billions of dollars more each year than it collects in taxes. And, because Americans buy hundreds of billions of dollars more each year in imports than they sell in exports, the country has effectively borrowed much of the difference from abroad, with foreigners amassing huge holdings of U.S. Treasury bonds and other securities.

Yet, some may find it curious that as the dollar continues to fall, the economy continues to grow, while European economies, with their strong Euro, look far less robust. The Bush folks do not seem concerned about the plunging currency, pointing out that the cheaper dollar benefits U.S. manufacturers. The Institute of Supply Management's widely watched index of manufacturing activity hit a 20-year high in November, adding credibility to the argument for a cheaper dollar.

Across the pond, a stronger Euro spells bad news for European firms, even if it means cheaper U.S. vacations for their employees. A rise in the Euro against the dollar raises the price of exports from European firms relative to American products, cutting into Europe's sales. Similarly, American firms' products become relatively cheaper, both for Americans and for foreign buyers. By creating more exports and letting market forces restrict imports, a weaker dollar should thus help cut America's huge trade deficit.

Although American tourists on overseas vacations can expect to pay more, and that German car or Brioni suit might seem a bit more pricy, some economists see the falling dollar as a necessary ingredient to ensure economic recovery. In a report to clients published by economists at J.P. Morgan Chase, the firm noted that “after five years of relative misery, U.S. manufacturers are beginning to enjoy significant, sustained market share gains in global markets.”

Investors looking to capitalize on the falling dollar might want to focus on large cap companies with well-established international markets, especially in areas where they might benefit from a global recovery. U.S.-based conglomerates, heavy industry and basic materials firms that do significant business abroad are likely candidates.

Another option is to buy stocks of foreign companies that are paying dividends in denominations of the foreign currency. A good example of this strategy is the purchase of Canadian oil and gas royalty trusts that pay dividends. As the Canadian dollar increases in value, the value of the dividend buys more in the U.S.