The U.S. dollar recently fell to its lowest level in six weeks. Unless you are about to travel outside the country, you might not immediately notice the impact of a weakening dollar, but if it continues to slide it could have a profound effect on your investments and your budget.
A weak dollar can lead to inflation, which would be especially damaging to savings at a time when bank rates are extraordinarily low. This may be a good time to consider some ways of protecting yourself against a weakening U.S. dollar.
Why the dollar is slipping
The value of the dollar has slipped in recent weeks when measured against a broad spectrum of foreign currencies. Currencies can be hard to track -- it's a little like judging someone else's speed when you are in a moving car. However, when the dollar is falling relative to a variety of other currencies rather than just one, it is fair to say this is a sign of weakness in the dollar rather than strength in all those other currencies. Notably, prices on commodities such as gold and oil have also been rising -- another sign that the value of the dollar is weakening.
The root cause of the dollar's woes are concerns about the U.S. economy. One after another, reports on economic indicators have been disappointing so far this year. Among other things, the struggling economy is leading investors to speculate on whether the Federal Reserve will have to rethink its monetary policy.
In each of its last two meetings, the Fed has announced that it is beginning to tighten monetary policy by cutting back on its quantitative easing program. The thought was that the economy was strong enough to survive without that artificial stimulus. However, if growth continues to sputter, the Fed may have second thoughts about scaling back quantitative easing.
The problem is that while monetary easing is often discussed as if it were a cost-free solution, it is not. By potentially undermining the creditworthiness of the U.S. government, it can erode the value of the dollar. The price of a weaker dollar is ultimately paid by everyone in the U.S., in the form of higher inflation.
An investor's choices
What is an investor to do in this situation? It is hard to find a safe harbor when inflation hits. Already, savings account and money market rates are not keeping up with inflation, and if price increases accelerate, bond yields will fall behind as well.
Investing in foreign currencies is one way to hedge against the weakening dollar, though currency investments are more volatile than what most people want from a risk management strategy. Foreign stocks are another possibility. They can benefit from the relative weakness of the dollar, while also tying your portfolio to more than just the U.S. economy. Closer to home, U.S. stocks that are heavy exporters can also be a way to hedge against a falling dollar. With their expenses in dollars and revenues in foreign currencies, exporters can be on the right side of a weaker domestic currency.
A side benefit to investing in foreign stocks is that it improves your diversification, and in the absence of any safe bets, spreading your money around may be the best thing you can do to manage risk.
(Ed. note: As this article went to press, the dollar had recovered to mid-February levels after investors sought safer assets amid tensions in Ukraine.)