If you have US dollars, this is of interest>
NEW YORK (CBS.MW) -- The long bull market in U.S. dollars from1996 to 2001 caused currency diversification to disappear completely from the radar screens of the average investor.
As U.S. dollar weakness begins in earnest, this should change, and in a big way.
Investors need to reacquaint themselves with the importance of global diversification at the same time they ponder the questions: how far could the U.S. dollar fall, and what will the potential impact of a falling dollar have on the U.S. economy and financial markets?
The foreign exchange market is the largest in the world, with over $1.4 trillion changing hands daily. Its price movements are the barometer of global commerce and the medium through which business facilitates the exchange of products and services.
Since 1996, U.S. consumers, in an unprecedented spending binge for foreign goods, used their strong dollars to create the largest U.S. trade deficit in history, now close to 6% of GDP. Under ordinary circumstances, a deficit of that magnitude would have caused the U.S. dollar to weaken long before now.
That the U.S. dollar didn't weaken sooner can largely be attributed to the multi-faceted nature of the currency markets and, to a significant degree, to the "miracle" U.S. stock market bubble of the 90's.
Enticed by seemingly endless upside, our foreign trading partners joined in the frenzy, recycling billions of the dollars they received from U.S. consumers back into U.S. financial instruments, propping up the dollar while helping to expand the bubble.
The stock market correction changed all that, and globally savvy foreign investors have begun in earnest looking for a safer home for their assets. In the first quarter of 2000, $66 billion of foreign investment flowed into U.S. financial assets. By the third quarter of 2002, the flow of foreign investment had slowed to just $7 billion.
Against this backdrop, U.S. dollar alternatives have benefited, with the euro up 17 percent last year and gold up 33 percent.
How far could the dollar fall? It is notable that currency cycles, once in motion, tend to stay in motion: 1972-1978, a significant drop in U.S. dollar; 1979-1985, six years of a strong U.S. dollar; 1986 - 1995, nearly ten years of U.S. dollar weakness; 1996-2001, a six-year period with the strong U.S. dollar tracking the burgeoning U.S. stock market.
As we are just 11 months into the current weakening, it would seem reasonable to anticipate that we may have several years, or even longer, of dollar weakening ahead of us.
On the positive scale, a weaker dollar should translate into U.S. products becoming more competitive in the global economy. For that reason, many analysts rightfully think that the U.S. government is not unhappy with the current direction of things.
There is, however, a wild card: China, which has pegged its yuan to the U.S. dollar. While unsustainable in the long run, the yuan/dollar peg serves, in the short-run, to keep China's products directly competitive against ours. That somewhat mitigates the commercial advantages that would otherwise inure from a weakening dollar. Following China's lead, other Asian nations are taking measures to cheapen their currencies as well.
Japan's central bank, for one, is believed to have purchased $75 billion on the currency markets over the past two years. For now, the path of least pain for these countries is to take overvalued dollars rather than let their currencies rise against the dollar. The latter option could structurally damage their manufacturing base by raising prices to the all-important U.S. consumer.
A tipping point may occur if China, bolstered by increasing domestic and regional consumption, decides to let its currency float. For obvious reasons, the National Association of Manufacturers is lobbying for the U.S. government to pressure China to do just that.
Unfortunately there is a lead lining in that outcome. A seriously weakening U.S. dollar will hasten the exodus of foreign investment from U.S. government bonds and other financial assets. In 2002 a euro-based investor lost 17 percent in currency depreciation on top of the 23 percent that they lost, on the average, in U.S. stocks. This is no small concern: foreign investors own as much as 42 percent of all our U.S. treasury bonds, and 18 percent of our long-term securities and stocks. Anything remotely resembling a "run" on U.S. assets could put devastating pressure on our markets and our economy.
The health of the U.S. dollar is, therefore, well worth the recent attention it has received. More to the point, U.S. investors should take steps to protect their own portfolios through global diversification, one of the foundations of modern portfolio theory. With the way things are going, the sooner your global positions are in place, the better. |
