Why a Weak Dollar Matters Right Now

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Economists, who can always find something to worry about, are wringing their hands over the future of the dollar. It might lose value against other currencies. It might not continue to be the world’s chief reserve currency...

OK, that doesn’t sound very good. But is it really something that noneconomists should care about?

Yes.

It especially makes sense to consider these hazzards when you think about investing and borrowing.

Any change in the dollar’s status can have ripple effects, though it can be hard to tell when the bad ripples outweigh the good ones.

Example? A weaker dollar means it takes more dollars to exchange for a given block of foreign currency, such as yen or euros. That makes foreign goods more expensive for American consumers. But it also means American goods are cheaper for foreigners, which is good for U.S. exporters, their employees and shareholders.

What Debt Does to the Dollar

Much of the current concern involves the U.S. government’s mushrooming debt, largely due to the financial crisis. On Aug. 23, the Obama administration said the government’s cumulative budget deficit will total $9 trillion over the next 10 years.

Warren Buffett, the legendary investor who heads Berkshire Hathaway Inc. (Stock Quote: BRK.A), has warned that debt-funded economic stimulus efforts that flood the country with cash can spur inflation. That undermines the value of bonds the government sells to cover the deficit.

Experts are also concerned that China and other countries may someday cut back their purchases of U.S. government securities, which they’ve long used to store excess cash. China, for example, might spend more of that cash to stimulate its own economy, and it could spread its investment of reserves among various other currencies.

Inflation and a weakened demand for U.S. bonds would undermine the dollar, since bond demand equates to dollar demand.

To attract investors who are less interested in those bonds and more worried about inflation, the government would have to pay higher interest rates. That could cause interest rates to rise for mortgages, car loans and other types of consumer and business debt.

There’s no guarantee all this will happen. In fact, inflation and interest rates have stayed remarkably low despite all these worries, and the dollar has held up well.

What You Can Do Now

Still, consumers and investors are wise to guard against the risk of higher interest and inflation.

Fixed-income investors, for example, can steer clear of long-term commitments. The 30-year U.S. Treasury bond yields a stingy 4.23% right now. If interest rates were to rise you’d have the unappealing choice of living with a low yield or selling the low-yield bond at a loss because investors would rather have newer ones that pay more.

One- and two-year certificates of deposit yield just 1.115% and 1.545%, respectively, according to the BankingMyWay.com survey. But they are attractive nonetheless because they will keep your money safe and are relatively accessible, so you could reinvest if rates went up.

Anyone interested in buying a new home should be aware that mortgage rates are at historically low levels and more likely to go up than down in coming years. If you worry that rates will rise, get a standard 30-year fixed-rate mortgage rather than an adjustable-rate loan.

It also makes sense to minimize the need to borrow money in the future, when rates might be higher. You could step up your savings for future college expenses, for example. It’s better to earn interest on savings than to pay interest on loans.

Long-term investors should remember that stocks have a role in hedging against inflation. A jump in inflation and interest rates does hurt stocks in the short run, because it increases companies’ borrowing costs and other expenses. But over the long term stocks’ returns tend to beat inflation by six or seven percentage points a year, while bonds barely keep up.

Finally, if you invest in foreign stocks or mutual funds that contain them, note that all else being equal it’s best to buy when the dollar is strong and sell when it’s weak. That way you get more shares when you buy and convert to more dollars when you sell.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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