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Without further adieu, let me prepare you for a time that may or may not happen. Let’s talk about falling currency, FOREX, gold, interest rates, debt and China. And how you can profit if it all hits the fan.
What are the disadvantages of a weakening U.S. dollar?
• Prices of imported products increase, leading to a higher cost of living.
• Traveling to other countries becomes more expensive.
• U.S. companies that buy products and materials from overseas will pay more...increasing the price of consmer goods.
There are two sides to every coin. Here’s the relatively good news of a weak U.S. currency.
• Becomes easier for U.S. firms to sell their goods overseas. Theoretically that is. We have to assume there is a strong demand.
• It’s cheaper for foreign tourists to visit the U.S. of A.
• Investing in the U.S. becomes more attractive to foreign investors. Especially U.S. treasury bonds.
This chart compares the value of two of the world’s most popular currency. USD and the Euro. The long term trend shows the dollar is weakening compared to its European counterpart.
As mentioned above, foreign investors like buying U.S. debt. To be more specific, foreign investors own almost 50% of all treasury bonds. China owns about half of that. Every year China lends us about $300 billion dollars by buying our bonds.
The good news is, by infusing the U.S. government with all this money, they’ve helped keep interest rates low and fund the budget deficit. The bad news is if China or other overseas bondholders decide to sell their holdings. If that happens, the U.S. will have to raise interest rates to attract other investors. Rising interest rates will not be looked kindly on by the U.S. consumer.
If a financial panic prompts the global community to sell off their dollar holdings the U.S. would experience a financial crisis. Already some countries are replacing their dollar reserves with the Euro.
Economics dictates that if the dollar weakens, U.S. companies should profit since their exports will be cheaper. The problem with this bit of hopeful thinking is, what does America have to export? We don’t manufacture like we used to becuase we can’t compete with China’s cheap labor.
Wait a second! We have music, TV shows and movies. The world loves U.S. entertainment. Worst comes to worst, Hollywood and MTV will save us.
What about software and services? Surely we’ve got the best brains in technology. Well, U.S. companies are outsourcing work to India. I'm not just talking about customer service and technology design. Legal services are outsourced, healthcare support, consulting and in about ten years you can have a root canal done via computer from Delhi.
If U.S. currency did experience a sharp decline, exports may not save the day. Without exports, we’d have high unemployment and inflation. Further compounding the problem is our ever increasing reliance on imports. Especially oil. And lately, it’s getting more expensive by the barrel.
What about bubbles. Is it possible that anytime something is overvalued it leads to a bubble? How do you know the bubble is about to burst when everything around you looks great?
During the nineties investors bought any stock that ended with the word “.com”. Oh, by the way…I'm guilty too. The recent real estate market is experiencing a similar type of crash. Lots of available funds lead to easy lending practices. Too many people watched Carlton Sheets infomercials and ended up defaulting on mortgages.
Top this off with the fact that Americans have the lowest savings rate of all time, are in debt and living longer than ever. Government spending is out of control and there hasn’t been much return on investment in Iraq.
Ok enough. I’m getting depressed. If the above scenario does materialize (and it may not), how do you profit?
Become a millionaire (more or less) with Penny Stocks!
• Fun with mortgages: Fannie Mae, Freddie Mac, Ginnie Mae are organizations that buy groups of mortgages and put them together in a pool. Investors can buy shares of these pools and collect the pass-thru interest. If you believe the housing markets hasn’t seen the worst yet, then buy long term put options on mortgage pools. As the value of these pools drop, you make money.
• Roll out the barrels: China needs oil. We need oil. As the price per barrel increases so will oil company revenues. Long term buy on good energy stocks or energy related mutual funds.
• Welcome to FOREX: Does the U.S. dollar have further to fall? Here’s a way to bet if it does. Buy put options on the dollar index.
• Go Euro: Want another way to make money on our falling dollar? Buy call options on the Euro. Most European nations have a trade surplus. This keeps their currency strong relative to the dollar.
• Goldfinger: Own gold. Stocking your basement with gold bricks is not really a speculative investment, but rather a hedge against inflation. Have no room for the bricks? Buy coins or ingots.
• Gold stocks: This play is for when you’re too busy to get to Vegas. Buy good smaller capitalized mining stocks. Go to a site like www.clearstation.com and do a search under gold & silver sector stocks. You'll find some real winners.
Will U.S. currency fall apart? There are books and research out there that claim it’s just a matter of time. And like any controversial topic there’s an army of economists who believe the U.S. economy can handle anything.
This ETF tracks the price of the EURO. It's the CurrencyShares Euro Trust (FXE).
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