Why Does the Weak Dollar Matter?


The dollar continues to fall against foreign currencies. Traders get excited about this sort of thing, but does it matter to ordinary folk?
Exchange rates do matter. If you buy a car or other good made overseas, or travel abroad, a weak dollar makes things more expensive.

But if you work for a company that does business overseas, a weak dollar can improve sales by making your firm’s goods and services cheaper for foreigners. And the falling dollar boosts gains if you already have foreign investments, such as mutual funds filled with foreign stocks.

So the falling dollar is a mixed bag.

During the past six months, the dollar has fallen about 15% when measured against the U.S. Dollar Index, a basket of six currencies such as the yen, euro and British pound. On Sept. 23 it hit the lowest level for the year.

Most experts attribute this to recession-fighting efforts by the U.S. government, which is pumping money into the system, increasing the supply. At the same time, low interest rates reduce demand for investments like U.S. Treasury securities, which foreigners use to invest in dollars.

Also, currency traders worry that huge U.S. budget deficits will prolong these conditions, and that an oversupply of money will spark inflation, further undermining the dollar.

There are several ways to hedge against the effects of a falling dollar, but they’re not all useful for small investors and consumers.

Trading in the currency markets is really for the pros and very serious amateurs, as things move very fast. Most currency trading involves leverage, or betting borrowed money. That amplifies potential gains but also boosts risks.

Buying gold or other commodities is also a traditional hedge against exchange-rate risks, and this has become easier in recent years with the creation of exchange-traded funds that specialize in these markets. But gold has not proven to be a great long-term holding, and commodities trading tends to be for the short-term, best left to the experts.

For small investors, investing in foreign stocks and bonds is probably the simplest way to dampen the effects of currency swings. If you buy when the dollar is strong, you will get more shares for your money, because your dollars will be converted to foreign currency to make those purchases. Selling when the dollar is weak generates foreign currency that is then converted to more dollars than when the dollar is strong.

Many financial advisers say U.S. investors should have 10% to 40% of their stock portfolios in foreign issues to get the full benefits of diversification. With the dollar weak, this probably isn’t the best time to jump into foreign investments with both feet, but it could make sense to gradually get your foreign holdings up to your target level during the next year or two.

The easiest way to invest in foreign securities is through mutual funds and exchange-traded funds. Most of the big fund companies offer one-stop-shopping with funds that invest in securities from many countries. The Vanguard Total International Stock Index Fund (Stock Quote: VGTSX), for example, owns European, Asian and emerging-market stocks. T. Rowe Price (Stock Quote: TROW) has the International Equity Index Fund (Stock Quote: PIEQX), and Fidelity has the Spartan International Equity Index Fund (Stock Quote: FSIIX), both similar to the Vanguard offering.

Over the long run, the dollar’s ups and downs tend to even out, so exchange rates are not something ordinary investors and consumers should spend too much time worrying about. For most people, the biggest concern is whether to vacation overseas. All else being equal, it’s best to do it when the dollar is strong and see the U.S. when the dollar is weak.

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