The sinking dollar

by Philip Brewer on 24 September 2007 16 comments
Photo: Philip Brewer

It takes more than $1.40 to buy one euro today. It cost less than $1 as recently as late 2002. A Canadian dollar is worth just about exactly a US dollar--a parity not seen since the 1970s. Should Wise Bread readers care? If so, what should they do?

Higher prices for imported goods

The most obvious reason for US readers to care would be if a lower dollar led to higher prices for imported goods. When exchange rates make the dollar worth less, it seems obvious that it would take more dollars to buy all the stuff imported for sale in the US. The fact is, though, prices are generally set at what the market will bear already and those prices don't change very quickly in response to changes in the value of the dollar.

The most immediate effect of of lower dollar is higher costs for importers--higher costs that they largely can't pass on to consumers. The result of that is a profit squeeze on the importers. Faced with such a squeeze, they do their best to push back at both ends--trying to get lower prices from their suppliers and trying to push higher prices onto their customers. It's hard to know to what extent they're being successful--companies keep that sort of data secret--but there's been no sign of a spike in prices for ordinary imported consumer goods.

Higher prices for raw materials

The price of oil, quoted in dollars, has risen for most of the year. Looked at in euro terms, though, the change is less stark. A $60 barrel of oil at the end of last year would have cost €46 versus €57 for an $80 barrel today--a 22% change in euro terms versus a 33% change in dollar terms. The price of oil really is up, but not as much as the price in dollars might suggest.

Oil isn't the only raw material, of course. Prices of most basic materials--iron, gravel, lumber and so on--are all up in dollar terms. Like with oil, this is partially a real increase in prices, and partially just an effect of the falling dollar.

(Given the high oil prices, the price of gasoline has been surprisingly low, at least in the US. Enjoy it while it lasts.)

Expensive travel

If you're an American traveling overseas, you will definitely notice the difference--everything will cost more. Without the buffering effects of importers and retailers who are willing to sacrifice some of their profits in the interests of maintaining market share or customer relations, you're stuck paying the local price.

People whose income and savings aren't in dollars

A good number of Wise Bread readers live in countries other than the USA. Of course, where you live doesn't matter so much as where you earn your money and how it's invested.

To the extent that your wealth and income are in something other than dollars, the decline in the dollar provides some initial benefits--commodities priced in dollars are cheaper, as are goods and services from US sources.

Longer-term, though, the benefits are less clear. Those foreign manufacturers benefiting because many commodities are priced in dollars, are in many cases the same ones taking a profit hit to keep selling to US importers. For those products where the US is still an exporter, the US firms have a growing exchange rate advantage--they can cut their price to foreign buyers and still bring home just as many dollars as before. If you're an owner or an employee of a firm with a US competitor, the lower dollar may hurt as much as it helps.

Longer term

Last week's Economist makes the point that, "It is how steadily the dollar is falling that counts, not how swiftly." However much importers and retailers try to buffer the changes from the falling dollar, over the longer term the exchange rate matters, and there are plenty of doomsday scenarios that play out if people in other countries decide that they'd just as soon not hold dollars anymore. Even a small shift in the preferences of the people and institutions that have been lending money to US borrowers could push the dollar down very quickly.

The only way to retain those investments, if people start to move money out of the dollar, would be to raise interest rates sharply. But with the US economy already suffering from the subprime lending crisis and the resulting financial squeeze, the flexibility for the Fed to do that is minimal--indeed, the Fed just lowered interest rates last week.

What to do?

Since we don't know which way exchange rates will move in the future, it's hard to provide any slam-dunk suggestions. Having some international diversity in your investments is always wise, but moving out of the dollar just as it hits record lows is not necessarily the best strategy. (You're too likely to find yourself unprofitably buying high and selling low.)

If it were easy, probably the best thing to do would be to arrange to have some international diversity of income. It would be very nice if everyone had 15% to 20% of their income in foreign currencies so that it would grow when the local currency fell and vice versa--adding a stabilizing influence to household income. Sadly, that's not really practical for most people. Working for a multinational corporation provides a tiny sliver of the same benefits, but most of the upside will probably go to investors rather than employees.

Still, as long as you have your income in the local currency, you can at least take advantage of the buffering effects mentioned earlier. The worst situation is to be living in a country with a rising currency while earning your income from a country with a falling one. (The situation of Americans living abroad just now.)

For most Wise Bread readers, there's probably no benefit to taking any sudden or major actions just now. Maintain or gradually work toward an internationally diversified investment portfolio. Consider trying to develop some foreign-source income. Over the medium-term, arrange to live in the same country that the majority of your income comes from. If you can do at least a couple of those things, you'll be fine.

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Andrea Karim's picture

On the same subject. :)

That's what I get for being slow. I'll just add that everyone should listen to this.

Myscha Theriault's picture

Bummer, huh? I've had the same thing happen a few times myself. I'm sure your next post will be awesome, just the same.

Good post, Philip.

Guest's picture
Mr Funk

...In Europe and Australia, where we get screwed by American / Japanese companies selling things at way beyond the US price already in our local markets. At the moment, I can import a 80gb PS3 from the US for about AU$250 less than the the local 60gb model, including shipping. And if the USD goes down any further it's just going to get better.

Guest's picture
Cidinho

². I really hope the dollar keeps falling until it'll be R$1 or less, so I can buy & have a Mac shipped for as low as in US.

Andrea Karim's picture

Buy up! Seriously, mate, you still owe us for foisting Crocodile Dundee on us back in the 1980s. Don't think we've forgotten.

Myscha (and Philip), I'm actually glad someone else covered this. Much better detail than I would have been able to give! 

Philip Brewer's picture

Heh. Sorry if I've stolen anyone's thunder. And, thanks for the audio link!

Andrea Karim's picture

Don't be sorry, Philip. Most of my article consisted of anti-Canadian material, as usual. You did a great job outlining the issues without going right over my head.

Guest's picture
Morris C

"The worst situation is to be living in a country with a rising currency while earning your income from a country with a falling one. (The situation of Americans living abroad just now.)"

Exactly right, and this is why so many Americans are learning the relevant languages of the Eurozone countries (German and French I guess being the two biggies, with Dutch nestling in there somewhere), and actually emigrating there to live, work and raise their children. I've been seeing this emigration for a while for American IT and other skilled workers hit hard by outsourcing and the H1B visa mania (and with college debts still to pay), but with the dollar decline, the trickle has become a flood. Nobody really going to places like Britain or Australia since they're having bank runs and debt crises of their own, but the Eurozone is really becoming a draw for both investments and labor.

Not hard to see why-- if you're a trained US high-tech worker and have some language skills, why languish in a job in the USA working ridiculous 80+ hour weeks in abusive environments, for diminishing salaries and the likelihood that you'll soon be laid off anyway, with lousy public schools and inevitably rising obligations (from our country's multiple wars), and worst of all, a tanking national currency that's increasingly worthless and erodes your real wages through inflation and other factors? When you could work in a gorgeous European city like Grenoble, Bonn, Antwerp, Rotterdam or Milan, with reasonable hours (usually 50-60/wk at most and often less), nice benefits, outstanding schools to send your kids to, plus getting paid in a currency like the Euro?

Especially for high-tech centers like the cities in Germany or Belgium, with the gorgeous surroundings of German cities and affordable cost of living (esp in eastern German regions following the Berlin Wall's tumble), the migration flows are easy to understand. I don't think that these flows will get too crazy and I suspect the situation will eventually self-correct somewhat, but the underlying push-pull forces for talented labor are definitely in the Eurozone's direction.

Guest's picture

The exchange rate depends on the market demand for dollars in
Europe. European economy has its own downturn and export to US is not as it should be. Remember Europe is expanding and looking for new markets in new members of European Union. I predict that Europe will be heavy regualated economy in nearest future and will move from free market to centralized Euro-conomy.

For average US family it is time to reconsider portofolio of mutual funds and stocks oriented in Europe or elsewhere. I would diversify so major developments in Europe will not affect my stocks.
It is not sign for major reconsidirations or portofolio changes just slight correction

www.efamilyfinance.com

Guest's picture
Nomi

As an American living in Europe, I can attest that this is really painful. I earn 90% of my income from the U.S. and the downward spiral really hurts. This last week alone, the exchange rate in Paypal went down almost 2% between the dollar and the Euro, which makes it difficult if you are trying to run a business because if you are in a service based business, you can't change your rates week to week.

As far as Morris' comment above about living in the Eurozone, I'm not sure that always makes sense. It's all relative really so just because you are earning in Euros doesn't necessarily mean you have a higher standard of living because often prices are relative to that too.

I don't know how it is in Germany, but in Spain the average wage compared to the cost of living is almost criminal. Most people I know are making about 1000 to 1500€ a month and paying 550-750€ of that just in rent alone and people are living with their parents well into their 30's.

Myscha Theriault's picture

Sorry if that got mis-communicated. What I meant was that since I share a great deal of your philosophies, I've often noticed posts from you while they are only still floating around in my head before I ever even start to write them down. You're just too darn savvy and fast for me, dude!

Keep up the good work! 

 

Philip Brewer's picture

Thanks Myscha (and everyone).

Guest's picture
Guest

Having a full 25% of your portfolio invested in foreign equities is wise in today's global economy and helps you participate in stronger currencies. Investing in large multi-nationals domestically also helps you reap the benefits of foreign currencies that are outpreforming.

There is an added form of diversification you get from owning stock in companies that are doing and growing their business abroad than you get from a firm whose revenues are solely based on one economy.

Philip Brewer's picture

While I generally agree that having some of your money invested internationally is a good idea, I'm not sure that 25% is the one true amount for all investors. In particular, since many large American companies do quite a bit of business overseas (both sales and manufacturing), just investing in an S&P 500 index fund gives you considerable international exposure.

If you have no investments at all, I'd suggest starting with something like an S&P 500 index fund. Only when that got pretty good sized would I suggest that you needed to think seriously about selecting an international fund to complement it. (That's for people living in the US with their income in US dollars. If a large fraction of your income or expenses is in another currency, that should also feed into your investment portfolio decisions as well.)

Guest's picture
Kelja

The mighty dollar is not looking all that mighty. But - remember - the dollar sinks or rises against other paper currencies. The Euro is hitting a new high against the dollar but that doesn't mean europe is the place to be financially. In the end it's all paper. The dollar will be abandoned and hence drop from here for a myriad of reasons, mainly our deficit.

Gold has risen in 5 years from $240 to $730 because it's becoming the currency of choice. As the dollar tanks, expect investors to flee the american equity market, both domestic and foreign investors, then Katy bar the door! After the big dip, some american assets will appear cheap to foreigners, things like Real Estate after it corrects back to 2001 or beyond prices, and american companies.

Philip Brewer's picture

I wrote a bit about gold as an investment a while back. Briefly, I think its "store of value" properties make it a much better buy when it is not approaching its all-time highs.