Politicians and regulators may be surprised to learn that the U.S. dollar follows the basic principles of economics just like anything else does. While politics does play some role in the value of the dollar, the laws of supply and demand are the biggest factors in determining the value of the dollar.
Those laws are rather simple to understand. As the supply of something increases, its value goes down. Decreasing supply increases the price of that commodity. The dollar is really just a commodity; something bought and sold in a free market with the price determined by the market participants.
In the past nine months or so, the government has been working overtime to create more dollars. Recent news reports noted that all of the government bailouts and rescues could end up costing as much as $23 trillion.
That amount, about two times the nation’s total economic output for a year, represents the worst case scenario, according to Neil Barofsky, the special inspector general for the government’s financial bailout programs.
Under the best case, no more bailout money would be spent. That still means the government has dramatically increased the supply of dollars over the past year. The Treasury Department reports that almost $2 trillion has already been spent.
All of this new money is proving that the law of supply and demand applies to the dollar. Since the bailouts began, the dollar is down nearly 15 percent, and many analysts see further declines ahead.
Foreign exchange traders earn profits by shorting the dollar against just about any other currency. In other words, they sell dollars and buy an equivalent amount of something like the yen or euro.
For those with large risk appetites, emerging market currencies offer even greater potential returns. The Brazilian real is up nearly 45 percent since its lows last December.
Trading foreign exchange involves a great deal of risk and is definitely not for everyone. The futures markets also offer an opportunity to trade the dollar for those willing to accept higher than average risk.
Risk averse investors can look to large cap stocks as an alternative way of profiting from a declining dollar. A silver lining to the declining greenback is that U.S. companies that depend heavily on exports should benefit from the declining dollar.
This is because the falling dollar means that profits earned overseas in foreign currencies are worth more to a company when the accountants translate those profits back to the U.S. dollar for reporting purposes.
Companies like Coca-Cola get more than half of their sales and profits from overseas markets. The average large cap company in the S&P 500 sees about 48 percent of its earnings come from outside the United States. This means a falling dollar will increase profits for these companies.
For larger companies like Boeing, it makes them competitive in overseas markets since they can deliver goods made with low-cost dollars and be paid with higher valued currencies, like euros.
While the declining dollar certainly has negative implications for interest rates, commodity prices, and the economy, individual investors can earn profits from the long-term trend. And, they can do it without the risk of highly leveraged foreign exchange or futures markets.
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