The Dollar: Soon to Swoon?

Bearish pronouncements on the greenback from Buffett and Pimco add to the market's unease. Here's what investors need to know

By Ben Steverman

Reports of the demise of the U.S. dollar may be premature. But when some of the world's most powerful investors are warning of the currency's decline, investors take notice.

Berkshire Hathaway (BRKA) Chief Executive Warren Buffett warned in a New York Times op-ed on Aug. 19 that the U.S. debt load threatened to turn the U.S. into a "banana republic economy."

A flood of greenbacks from the Federal Reserve and the Obama and Bush Administrations may be necessary now to prop up the ailing economy, Buffett said. But the government must control its debt in the future—or risk the consequences.

"The dollar's destiny lies with Congress," Buffett wrote.

On Aug. 20, the head of the world's largest bond fund, Pimco Chief Executive Mohamed El-Erian, sounded as though the dollar's decline were a foregone conclusion.

"The question is not whether the dollar will weaken over time, but how it will weaken," El-Erian told Bloomberg, echoing Pimco founder Bill Gross, who has said the dollar could lose its status as the world's reserve currency. "The real risk is that you will get a disorderly decline," El-Erian said.

The Dollar as Safe Haven

The problem with such bold pronouncements is that the currency markets are notoriously unpredictable. An accurate currency forecast makes a correct stock pick look easy, as it requires foresight into economics, trade flows, capital flows, politics, and market psychology—all on a global scale.

In the late 1980s many worried the U.S. dollar was losing out to the Japanese yen and other world currencies. But those worries were quickly forgotten in the 1990s as U.S. deficits narrowed and growth heated up.

Last fall the value of the dollar spiked as the world sought refuge in its strongest currency. That had little to do with economic fundamentals. Ironically, it was a U.S.-born financial crisis that was causing investors to push their assets into U.S. dollars.

Perilous Predictions

This is an especially treacherous time for currency prognosticators. "I've never known a period when there were more different views about a wide range of different factors in global economics," says Giles Conway Gordon, co-chief investment officer at Cogo Wolf Asset Management.

For example, forecasts for the value of the euro vs. the U.S. dollar are all over the map. The shared European currency fetched $1.43 in trading on Aug. 20. Some respected commentators, Gordon notes, are predicting that by the end of the year the euro will be at $1.12, while others are predicting $1.60. "There are huge variations," he says.

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