All Things Financial Planning Blog

I often tell clients that there are very few things in the financial world that keep me up at night. Of those few things, the U.S. dollar currently ranks number one on top of my worry list. It’s not the paper itself, but the value of our nation’s currency relative to the rest of the world’s currency. The U.S. has relied on the strength of the dollar and its ubiquitous use around the world as economic and political muscle. The acceptance of the U.S. dollar as the world’s currency has allowed our government and its peoples to fund ever growing budget deficits that have racked up trillions of dollars in IOU’s over the last 30 or so years. 

For the vast majority of American’s, they really don’t worry about the value of the U.S. dollar relative to the rest of the world’s currencies. They usually don’t negotiate bilateral trade agreements or forward currency swaps. We go to the grocery store, fill up our gas tanks and vacation here in the beautiful 50 states. Swapping dollars for euros, swiss francs or pounds is as foreign as Agneau Roti Jardinier. But the value of the U.S. dollar relative to our trading partners is extremely important and has huge financial implications for our citizens and our government.

Since 1985, the U.S. dollar has lost nearly 50% of its value. Briefly recovering during late 90’s and early 2000’s, the dollar resumed its decline in earnest ever since. Nearly every major commodity is denominated in U.S. dollars. Oil, gold, zinc, tin, natural gas, corn and a cast of hundreds are all pegged to the U.S. dollar. Given the fact that the United States predominantly imports more than we export, every percentage decline in the value of the dollar leads to higher costs domestically. One of the main reasons the price per barrel of crude oil is so high is the relative weakness of the U.S. dollar. Gold – similar concept. If you compare a chart of Gold to the U.S. dollar you will see a very interesting inverse correlation.

There is a seismic financial change that has been occurring over the last several years. China has surpassed Japan as our largest creditor. China currently holds nearly $4.5 trillion dollars worth of U.S. long-term treasury debt. The Chinese government is using its burgeoning surpluses to buy up foreign debt along with gold and basic commodities. The fact that China is currently running large trade surpluses is not of concern. What is of major concern is the fact that China’s recent bilateral trade agreements (major trade agreements between countries) will no longer be denominated in U.S. dollars, but will utilize the currencies of the trading partners instead. 

The historical use of the U.S. dollar is rooted in the post World War II Bretton Woods agreement. The United States came away from the great world war in better shape than the rest of the world which gave them remarkable bargaining strength during the negotiations. Most of Europe’s industrial capacity was decimated during the war. The Allies, especially Great Britain, were deep in debt. The Bretton Woods agreement paved the way for the U.S. dollar to be the world’s reserve currency. The U.S. dollar has held that privilege ever since.  

Now, the bargaining strength has deteriorated. The rise of China, India, Brazil, Turkey, Russia and other nations has diminished the role of the United States. These nations no longer see their respective currencies as a risky medium of exchange but as a store of value, especially against the U.S. dollar. 

So why again should we care? So much is dependent on the world buying dollars which helps the U.S fund its current account deficit. So much has been made lately of the governments of Greece, Portugal and Spain not being able to potentially fund future government deficits through the issuance of sovereign bonds. Should the U.S. find itself in a similar situation, the cost of servicing our debt will sky rocket creating even greater pressure on the United States.

What if anything should an investor do to protect against the decline of the U.S. dollar? One way would be to invest in foreign mutual funds that do not hedge their currency exposure. Check the mutual fund’s prospectus for detailed description of the fund’s risks and investment objectives. Another hedge against declines in the dollar is to buy Certificates of Deposit that are denominated in foreign currencies. Talk to your local bank about their offerings or search the internet for highly rated banks offering this type of investment. One investment strategy that has been gaining a lot more attention as of late is gold or other commodities. This area has had tremendous gains over the last several years with some experts predicting the run may be over. But with these and other strategies, understanding the risks prior to committing any risk capital is key to your overall financial success. Should the world begin to lose faith with our slogan “In God We Trust” emblazoned on our currency, we will be in for difficult times.

Edward Gjertsen II, CFP®
President
Mack Investment Securities, Inc.
Glenview, IL