Will a Falling Dollar Derail Your Plans for Retirement?

Home
>
Investing
>
Will a Falling Dollar Derail Your Plans for Retirement?

Will a Falling Dollar Derail Your Plans for Retirement?

How much are you willing to pay for a tank of gas? We've all watched as gas prices hit record highs, but what would you do if you filled your tank and paid by credit card only to discover on your monthly statement that you paid $80 to fill an economy car. No, this is not some future doomsday projection of oil prices. This scenario recently happened to a colleague on business in Europe.

You're not planning a trip to Europe, so you ask, "Who cares?" Well, the consequences of a weakening dollar are not limited to overseas transactions. It's important for you to know exactly how the declining US currency affects Americans state-side.

What does this mean to you?

The US dollar is considered the world trading currency. This means that most goods and services are priced in US dollars. Any prolonged weakness will cause countries trading with the US to raise their prices in anticipation of further decline. Many commodities such as, oil, coffee, chromium, copper, and iron have already set record prices due to the decline in the dollar. As the prices for foreign imported goods increase, so do the prices for the raw materials and parts used by US businesses. As a result, the price will also increase on all goods produced within the US. In short, Americans will pay more and receive less.

This economic effect is known as inflation and its impact is particularly devastating to retirement and savings portfolios. This decline in the US dollar means a reduction in the purchasing power of the dollar and a corresponding reduction in the standard of living for those who earn, spend and save US dollars. In short, a weaker dollar means that Americans will work harder for less.

What is going on with the US $?

In December of 2004, the dollar hit an all time low against the euro at $1.3667. This was down sharply from $1.20 in September of 2004. (Source: Associated Press MSNBC.com, December 30, 2004)

The Euro isn't the only currency rising against a falling dollar. The Australian dollar is trading at six month highs and the Japanese Yen is near its highest trading rate in 8 months. The Canadian Dollar has just moved to multiyear highs against the US currency. (Source: Jubak TheStreet.com, November 10, 2004)

Foreign investors are closely watching the huge US deficits in the federal budget and trade accounts. According to the Commerce Department the trade deficit of the USA was $618 billion in 2004. The Congressional Budget office projects a $400 billion budget deficit for 2005 and the current US national debt is nearly $7.7 trillion.

Budget deficit = spending more than tax revenues collected. Trade deficit = buying more imports than you sell exports. National debt = Accumulated deficits + accumulated off?budget surpluses

CRN 0503-1256

A major cause of the current deficit is the result of increased growth rates in the U.S. When the U.S. grows faster than other world economies, we consume far more goods and services from overseas than they consume from us. This creates the imbalance in our trade accounts that we are experiencing today.

We also need to be mindful of the effects that the flow of foreign investment dollars into the US has on our economy. The US markets had a larger return on capital than Europe or Japan for the last 20 years. Foreign governments such as China and Japan have also purchased large amounts of US Treasury securities as a reserve, in order to back their own currencies and guard against the dollar from falling too fast and hurting their economy.

Worldwide currency traders recognize these trends. And investors view the increased spending on the war in Iraq, the massive cuts in tax revenues and the possibility of Social Security privatization as signs that budget and trade deficits will continue to escalate.

What are the Professionals saying?

Bill Gross the managing director for PIMCO, one of the worlds largest fixed income managers said, "Real interest rates in the United States will have to be kept low". He goes on to say, "Too much debt in a finance-based economy precludes raising interest rates like we have in the past and while that keeps the patient/economy breathing; it leads to asset bubbles, potential inflation, and a declining currency over time." Bill Gross hints at a continued slide in the value of the dollar but the real question is: what does this mean?

There are three main schools of thought regarding America's current economic situation with respect to the falling dollar.

Reduction of the trade deficit perspective

Some experts say that the dollar's fall is good because it makes US exports less expensive and that higher demand will cut the trade deficit. This group also contends that global financial markets are awash in so much money that the US can borrow much more than seemed possible 20 years ago.

The dollar may decline in value, according to this view, but the decline would be gradual and would help reduce American trade imbalances by making exports cheaper and imports more expensive.

The Bush administration goes one step further, arguing that America's huge foreign debt simply reflects the eagerness of others to invest here.

"Productivity has been remarkably high in the last few years," said John Taylor, deputy secretary of the treasury at a recent conference. "Foreigners want to invest in the United States. That's what the gap illustrates."

International investor perspective

A second school of thought holds that foreign governments like China and Japan will continue to finance American borrowing and keep the dollar strong because they are determined to sustain their exports and create jobs.

International investors own $1.9 trillion of the $3.8 trillion of marketable U.S. Treasury securities. (Source: Gilbert Bloomberg.com, November 17, 2004)

Possible Dollar collapse perspective

A third school, which includes officials at the International Monetary Fund, worries about a collapse in the dollar that would send shock waves through the global economy.

Former U.S. Treasury secretary Robert Rubin warned last November that the dollar's recent decline could accelerate and interest rates could rise if politicians in Washington don't act quickly to narrow the federal budget deficit.

Alan Greenspan speaking at a banking conference in Frankfurt on November 19th, 2004 said: "Anyone who has not appropriately hedged his position by now is obviously desirous of losing money". He went on to say, "Net claims against residents of the united states cannot continue to increase forever in international portfolios at their recent pace." And in his now famous enigmatic fashion he dropped the bomb, "Continued financing even of today's current account deficits as a percentage of GDP doubtless will, at some future point, increase shares of dollar claims in investor portfolios to levels that imply an unacceptable amount of concentration risk."

A steep drop in the dollar could lead to higher interest rates for the federal government and American private borrowers, as foreign investors demand higher interest rates to compensate them for higher risk.

Legendary investors hedge their bets

Savvy investors from all walks of life are taking this opportunity to diversify their portfolios and hedge their US Dollar bets. According to Forbes Warren Buffet owns 20% of the world's silver, Bill Gates owns 10-20% of Pan American Silver mines, and George Soros also has holdings in gold and silver mines.

What can you do about it?

You've heard the old investment adage, "Don't put all of your eggs in one basket." This is a good time to be reminded that a well-diversified portfolio should be the core of any well-planned investment strategy. And the construction of a well diversified portfolio begins within the framework of Modern Portfolio Theory.

Modern Portfolio Theory is the philosophical opposite of traditional stock picking. It is the creation of two economists William Sharpe and Harry Markowitz who won the 1990 Nobel Prize in economics for their work. Their quest was to try to understand the market as a whole. Investments are described statistically, in terms of their anticipated long-term return rate and their expected short-term volatility. The volatility is equated with "risk", and it measures how much worse than average an investment's bad years are likely to be. The goal is to identify your acceptable level of risk tolerance, and then to design a portfolio with the maximum potential return for that level of risk

Remember, no single type of investment performs best under all economic conditions. A diversified program is capable of weathering varying economic cycles and helps to improve the trade-off between risk of loss and expected return. Of course, diversification helps to reduce risk but cannot entirely eliminate the risk of investment losses.

Most experts recommend analyzing investment portfolios at least once per year. By identifying weaknesses and making adjustments, you can help ensure that your portfolio is performing efficiently.

According to an often-cited and time tested study* held in high regard by many professional investment managers, more than 90% of investment success is due to asset allocation rather than stock selection or any other strategy. This means that investors who carefully allocate their assets among a variety of asset classes (cash, bonds, stocks, etc.) have a greater potential of lowering their overall investment and market risk than those who invest only in one asset class. It is one of the key factors in the investment planning process. (*Source: Brinson, Singer & Beebower Financial Analysts Journal, May-June 1991)

Bottom line is that wise investors don't try to second-guess the financial markets. They take a structured, disciplined approach to investing that recognizes that market declines inevitably will occur. The overall strategic composition of a portfolio will not change unless the investor's situation changes substantially. However, you can use the periodic portfolio reviews to make tactical adjustments depending on prevailing economic conditions. One of the best ways to prepare for economic uncertainty is to have a well diversified portfolio in place and a plan to ensure that it maintains a high probability of helping you reach your goals.

Christopher T. Lawson, financial planner, is a registered representative of Lincoln Financial Advisors Corp., a broker/dealer. Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor, 31111 Agoura Road Suite 200 Westlake Village, CA 91361 (818)-540-6916.

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results.

Mr. Lawson has over 11 years experience providing sound financial advice to Corporate pension plans and affluent families. He is a financial Planner with Sagemark Consulting and has presented at regional and national conferences for the following companies: Linsco/Private Ledger, American Express Financial Advisors, Associated Securities, TD Waterhouse Securities, and World Marketing Alliance. He has also worked with Merrill Lynch, UBS PaineWebber, Salomon Smith Barney (CitiGroup), and American Skandia (a Prudential Company).

In The News:

Yahoo! News: Top Stories

Dow drops nearly 680 on consumer spending worries (AP)

AP - The reality that the nation is indeed in recession and that the downturn may well be prolonged sent Wall Street plunging Monday, hurtling the Dow Jones industrials down nearly 700 points and wiping out more than half of last week's big gains. All the major indicators fell more than 7 percent, with the Standard & Poor's 500 index down nearly 9 percent.

Obama announces Clinton, Gates for Cabinet (AP)

AP - Barack Obama announced a national security team Monday headed by Hillary Rodham Clinton, who fought him long and bitterly for the presidency, and Robert Gates, the man who has been running two wars for George W. Bush striking choices by a president-elect who declared he wanted "strong personalities and strong opinions."

Bush uses final 50 days in office to tout legacy (AP)

AP - President George W. Bush says history will judge him, but he is getting his own crack first. Bush is using his final 50 days in office to tout his legacy, hoping to leave a lasting impression of overshadowed progress. On Monday, World AIDS Day, Bush was heralded for his leadership in fighting the disease, a point that even his Democratic critics readily concede.

Estranged relative arrested in Hudson killings (AP)

AP - Jennifer Hudson's estranged brother-in-law has been arrested in Illinois in the deaths of the singer's mother, brother and 7-year-old nephew.

India demands strong action from Pakistan (AP)

AP - India demanded Monday that Pakistan take "strong action" against those behind the deadly Mumbai attacks, and Washington pressured Islamabad to cooperate with the investigation.

Palin implores Ga. Republicans to back Chambliss (AP)

AP - Alaska Gov. Sarah Palin urged Georgia voters to back Sen. Saxby Chambliss in Tuesday's runoff in an election eve appeal that underscored her popularity within the Republican Party and the GOP's efforts to stave off erosion of its shrinking Senate numbers.

Parents: Slain anchorwoman was sexually assaulted (AP)

AP - The parents of the television anchorwoman who was beaten to death said Monday there is evidence their daughter also was sexually assaulted, and that she broke her hand fighting her attacker. Five days after a suspect was arrested in the Oct. 20 beating of KATV anchorwoman Anne Pressly, Guy and Patti Cannady said on NBC's "Today" that the family still has many questions about the killing.

1 in 5 young adults has personality disorder (AP)

AP - Almost one in five young American adults has a personality disorder that interferes with everyday life, and even more abuse alcohol or drugs, researchers reported Monday in the most extensive study of its kind.

Man says God ordered him to ram vehicle at 100 mph (AP)

AP - A man who rammed his truck into a woman's vehicle on a highway early Friday told authorities he crashed into her while going more than 100 mph because God told him "she needed to be taken off the road."

Burress appears in court, has bail set at $100,000 (AP)

AP - Taken to court in handcuffs, Plaxico Burress posted $100,000 bail on weapons possession charges Monday as a frenzy grew around the case of the Giants star receiver who accidentally shot himself in a nightclub.

Obama names Clinton, Gates to lead foreign policy (Reuters)

Reuters - U.S. President-elect Barack Obama named former rival Hillary Clinton as secretary of state on Monday and said Robert Gates would remain defense secretary in a national security team charged with recasting America's leadership role in the world.

Stocks slide as economy, Bernanke raise fears (Reuters)

Reuters - Stocks tumbled on Monday as news pointing to the deepening economic slump around the world erased much of last week's sharp gains, with financial services companies and retailers among Wall Street's biggest casualties.

India demands Pakistan act decisively on Mumbai attack (Reuters)

Reuters - India demanded Pakistan take decisive action over deadly attacks in Mumbai it said were carried out by militants from its nuclear-armed rival, while the West urged cooperation to ease tension.

Bush calls flawed Iraq intelligence biggest regret (Reuters)

Reuters - President George W. Bush said the biggest regret of his presidency was flawed intelligence that Iraq had weapons of mass destruction and told ABC "World News" in an interview airing on Monday that he was unprepared for war when he took office.

U.S. in recession, Europe backs spending hikes (Reuters)

Reuters - The U.S. economy has been in a recession for a year, the nation's business cycle arbiter declared on Monday, while European leaders vowed to step up public spending to try to cushion a deepening downturn.

House to push $500 billion stimulus bill (Reuters)

Reuters - U.S. House of Representatives Speaker Nancy Pelosi met leading governors on Monday to discuss the size and shape of an economic stimulus package that one Democratic aide said was likely to cost around $500 billion.

Thai protesters consolidate hold on airport (Reuters)

Reuters - Thai protesters prepared to end their three-month occupation of the Prime Minister's office on Monday to consolidate their grip on the main airport ahead of a court verdict that could dissolve the elected government.

Alabama mayor arrested on corruption charges (Reuters)

Reuters - Federal authorities arrested the mayor of Birmingham, Alabama, on Monday in a corruption probe surrounding a massive sewer bond debt that has forced Jefferson County to the brink of bankruptcy.

Hawkish Obama names Clinton as top diplomat (AFP)

AFP - Barack Obama on Monday nominated Hillary Clinton to be his "tough," "smart" secretary of state as his former foe vowed to give her all to steer America through a storm of international crises.

Mumbai attacks: India demands Pakistan take 'strong action' (AFP)

AFP - India on Monday formally accused "elements" in Pakistan of being behind the devastating Islamic militant attacks in Mumbai and demanded that Islamabad take "strong action".

Will a Falling Dollar Derail Your Plans for Retirement?

Investing Investing