The value of the dollar: Five factors for investors

Barry Ritholtz
Columnist April 23, 2011

To most investors, the value of the dollar is an abstraction; its fluctuations are mostly ignored. Any currency, the dollar included, must be viewed relative to other currencies. You work in, get paid with and consume goods using dollars. Without a frame of reference to analyze it, the fluctuations have little meaning.

The time people seem to really notice is when they travel overseas and discover that it is not worth nearly as much as they expected. (“Forty dollars for a hamburger in London? Outrageous.”) As an investor, you may not be aware of what this ultimately means — to the economy, your investments and the nation. But it matters more than you realize — and it’s not just about pricey hamburgers.

Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. View Archive

To help you wrap your head around the value of a dollar, let’s look at five factors:

1 The dollar matters a lot: The value of the greenback determines how competitive U.S. goods and services are on the world market.

You can see this in the dollar’s impact on how much we sell overseas and what our imports cost. The U.S. economy exports almost $2 trillion of goods and services a year. Each month, we import more than $200 billion worth of stuff, creating a monthly trade deficit north of $45 billion.

Many politicians talk about a strong dollar, but it’s mostly lip service. A weak dollar helps to create jobs by making U.S. products more price-competitive overseas. Indeed, many countries try to accomplish the same thing, creating a “beggar thy neighbor” policy. The global recession led to nearly every country in the world trying to export its way out of a slowdown.

Warren Buffett has noted that “in the years since I was born, the dollar has depreciated 94 percent. It’s 16-for-1 in terms of inflation.” But, Buffett went on to point out, you earn 16 times as much as you used to. Costs are relative to your earning power, and to investors, what matters most is the earning power of companies that sell goods and services.

2 Inflation and the dollar: Inflation, Paul Volcker said, is the cruelest tax. The soft dollar has contributed to rising inflation since former Fed chair Alan Greenspan took rates down to 1 percent in the early 2000s.

This is the price to be paid for making the dollar weaker to create those jobs. Commodities are priced in greenbacks. Most notably, food and oil are also dollar denominated. As the measuring stick (the dollar) gets smaller, commodity prices rise. When you see gas prices exceed $4 a gallon, and the costs of various foods rising, much of that is related to the dollar’s slide.

Rising food prices and higher energy costs are felt most harshly by lower- and middle- income consumers and by retirees living on a fixed income. When the prices of these essential rise, it eats into their discretionary spending.

Let’s not forget that metals are also priced in dollars — including gold. It is up 500 percent over the past decade, hitting $1,512 last week. This reflects a double concern: that the dollar is weakening, and that inflation is stirring.

3 From 2001 to 2008, the dollar collapsed 41 percent: While that 94 percent drop in Buffett’s lifetime is substantial, the past decade saw a full-blown collapse. The buying power of the dollar was cut nearly in half from 2002 to 2008.

That collapse was triggered by the ultra-low rates by the Federal Reserve, and an (arguably) unpopular U.S. war in Iraq. The rates under Alan Greenspan kicked off a vicious cycle of increased prices, low returns on bond investments and higher inflation. Price spikes in oil, gold, food and housing — everything priced in dollars — followed.

4 The weak dollar policy forces money into riskier assets (and punishes savers): The Fed hasn’t explicitly stated that cash is trash, but it might well have. After Chairman Ben Bernanke’s op-ed in The Washington Post in November, many observers concluded that the Fed was trying to force cash out of hiding into the economy.

Just as deflation encourages consumers to hold onto their money and wait for lower prices, inflation encourages consumers to spend their cash and beat the price increase.

With rates low and the dollar’s value in decline, some have argued that the Fed is forcing money into more productive uses. In theory, that includes expanding businesses, hiring and making capital investments.

What has really happened? While there has been some business hiring, it has been sub-par — typical in a post-credit crisis recovery. But it has led to speculation in commodity and equity markets. Rising stock prices and soaring commodity prices are a function of the Fed blunting the dollar.

5 In the land of the blind . . . There are four major currency blocs — the dollar, the euro, the yen and the yuan. With so many factors against it, why would anyone want to own U.S. dollars? Because, well, it’s the least ugly currency of the lot.

The Europeans are still not only dealing with an ongoing banking crisis. Portugal, Ireland, Italy, Greece and Spain all have solvency problems. Lacking their own currency, these nations cannot simply print their way out of debt. Thus, there is a small but real possibility that the European Union will not hold, and the euro will collapse.

Japan is even worse. It was mired in a multi-decade slog, and then the earthquake/ tsunami/nuclear crisis rocked it back on its heels.

That leaves China. Despite market reforms, it is still a totalitarian communist regime. Western nations are none too keen about making its currency the reserve of the world.

To the dollar then. In the land of the blind, the one-eyed man is king.

Ritholtz is chief executive of FusionIQ, a quantitative research firm. He runs a finance blog, The Big Picture.

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