Portfolio Investments for a Weakening Dollar

Multicurrency bank deposits, U.S. multinational equities, and Asian bonds are a few ways to play what some regard as a necessary dollar correction

By David Bogoslaw

Given so much weakness in the U.S. dollar lately, there are probably lots of people wondering how it will affect their investment portfolios before the currency stabilizes.

The greenback has hit a rough patch—as evidenced by a 1.04% decline in the U.S. dollar index, which measures it against a basket of currencies, over the past week. One reason for the speculative run against the dollar was the failure of a statement defending the dollar to emerge at the summit of financial ministers from the Group of 20 countries in Pittsburgh in late September, according to Brian Dolan, chief currency strategist at Forex.com.

The omission rekindled speculation that the oil-producing nations are seriously considering an end to trading crude in dollars and are moving instead to price it against a basket of currencies, including gold. Oil-producing states have once again denied the rumor.

Despite that and general agreement that any credible challenge to the dollar's status as the world's preeminent reserve currency is probably several years away, the dollar could still depreciate by another 10% before it stabilizes.

William Cline, senior fellow and resident global trade specialist at the Peterson Institute of International Economics, puts the currency's recent decline in context. Although the dollar has depreciated by about 9% over the past seven months, that is just a partial reversal of the 12% bounce it had from its recent low in March 2008—the result of its enhanced allure as a safe haven for investors when the financial crisis hit.

a further 5% gain for the euro?

Even at its pre-spike March 2008 level, the dollar was overvalued, says Cline. If the dollar had stayed at the inflated March level for a couple of years, it would have driven the U.S. current account deficit up to 5.5% of GDP by 2011, he says. "A desirable target is 3% of GDP, so we needed to have this dollar correction," he says. "We have had more than half of that correction since March. I see room for another 8% to 9% decline in the dollar" before it returns to what he calls its fundamental equilibrium exchange rate.

Any further decline ideally would come against some Asian currencies, especially the Chinese yuan, but part of it will also come from a likely 5% additional gain in the euro, Cline adds. The rule of thumb is that a 10% decline in the exchange rate would lower the current account balance by between 1% and 1.5% of GDP, requiring one to three years for the full effect to be seen, according to Barry Bosworth, senior fellow at the Brookings Institution in Washington. While the U.S. trade deficit is actually considerably lower than during the summer of 2008—before the financial crisis—that’s mostly due to the global recession, which has caused imports into the U.S. to drop even more sharply than exports.

As fear of another Great Depression has ebbed, investors have turned their attention to the null interest to be earned on U.S. Treasury bills and are moving into riskier assets that offer higher returns. The zero interest on short-term government debt has caused more than $500 billion to move from money market accounts to corporate and longer-term government bond funds since January.

But won't a weaker dollar make it harder for U.S. Treasuries and other dollar-related assets to attract the foreign capital needed to sustain the enormous U.S. current account deficit? Charles McMillion, chief economist at MBG Information Services in Washington, thinks so—and he believes this increases the chances that the Federal Reserve will raise interest rates to keep money flowing in from overseas.

Since the Fed's priority is to bring unemployment down, some strategists think the likelihood of a rate hike soon is practically nil. The central bank would sooner expand its purchases of Treasury bonds to keep the Treasury flush with cash, says Tim Knepp, chief investment officer at Genworth Financial Asset Management (GNW).

EverBank's multicurrency deposits

What's good for Main Street, however, isn't always good for Wall Street. So what should investors do to minimize their portfolios' exposure to the weaker dollar?

For those who worry about the softer buck but still prefer to own cash over higher-risk assets, EverBank Financial offers a multicurrency account with as many as 20 different sub-accounts for various foreign currencies under the main account. Depositors can hold their money either in fully liquid money market accounts or certificates of deposit with a minimum term of three months. The interest rates on foreign currency deposits are based on the interest rate structures of the countries whose currencies an investor chooses to own.

Business Exchange

Track and share business topics across the Web.