Thursday, November 17, 2005

The U.S. Dollar has to eventually weaken

The U.S. Dollar has appreciated (i.e., strengthened) relative to foreign currencies so far this year. However, in the long term, the U.S. dollar has to weaken. There's absolutely no doubt that this will happen. When it does happen, foreign-denominated assets such as foreign stocks should outperform U.S. stocks for some period of time.

The U.S. has been running trade deficits since the 1970s. However, the trade deficits have been accelerating in recent years. This year alone, the U.S. trade deficit is projected to exceed $700 billion. This means that the U.S.'s imports exceed its exports by $700 billion.

With U.S. dollars in hand, the foreigners can either exchange the dollars for another foreign currency or invest the money back in the U.S. by purchasing U.S. assets. For example, much of the dollars are invested in U.S. treasuries or in the stock market. This is probably because interest rates are higher in the U.S. than they are in other parts of the world. Accordingly, foreign investors are currently getting a good return on their invested dollars.

However, at some point this will have to end. In the nightmare scenario, the dollar begins depreciating (i.e., weakening) until froeign invesotrs decide that enough is enough and start quickly selling off their U.S. assests, accelerating the dollar's depreciation. As the dollar depreciates, the cost of imports will likely rise, resulting in strong inflation in the U.S. and causing either a recession or possibly even a depression.

To hedge one's bets, one can purchase foreign stocks and hope for the best. However, if a depression does occur, foreign stocks and foreign economies would likely also suffer, as the U.S. is a big source of revenue for foreign economies. So a good alternative investment may be gold, the universal money.

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