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How Does the Strength or Weakness of the U.S. Dollar, Inflation, and Monetary Policy Impact my Personal Financial Condition?

How Does the Strength or Weakness of the U.S. Dollar, Inflation, and Monetary Policy Impact my Personal Financial Condition?

This discussion is written as a follow-up to an article I wrote for this web site in late 2009 entitled "Strong Dollar? Weak Dollar? What Does it Mean to Individual Investors?" The same trends warrant further attention as the U.S. economy is even more entrenched in the "cheap dollar" policies of the Federal Reserve Board. Whether we are invested in the stock market, savings accounts and CDs, real estate, or various commodities such as gold or oil, our results are directly impacted by the strength or weakness of the U.S. Dollar against other global currencies. A very simple and straight forward approach to understanding the relationship between the dollar and commodity markets (all goods and services) is to understand that when other currencies become stronger against the dollar, they have a greater purchasing power for goods priced in dollars. The main global markets for energy and precious metals, two barometers for economic growth and world financial health, are priced in dollars. Gold and silver are traded globally, but every major stock exchange market, e.g., Hong Kong, London, Tokyo, and New York, all report daily prices in U.S. Dollars. The same is true for crude oil and the major refined petroleum products.

Since these major products are priced in dollars, there is a tendency to watch the dollar's value as it relates to other currencies very carefully. As the dollar weakens, and the purchasing power of other economies gets stronger, they tend to buy more goods and services priced in dollars. As a result, U.S. exports increase, more jobs are created, and more people are employed. Consequently, it is understandable why many countries want their currencies to be devalued against the dollar to experience increased demand for their goods and services.

One method used by policy makers, the Federal Reserve Bank (FED) in this instance, is to lower the dollar's relative value by pushing interest rates lower. The FED has continually pushed U.S. interest rates lower since the height of the financial crisis in 2007. Lower interest rates force money across borders to where the interest rates are higher and investors receive a greater return. Recently, many Americans who do not have access to international markets and banks, and the resultant higher interest rates, have again put their money into the stock market. You can see the returns on the stock market since just the beginning of the year have been tremendous. Due to the attractiveness of such performance, more and more money has moved from savings accounts and fixed income instruments, such as bonds, back into the stock market.

If you have followed this column for any period of time, you will know that in addition to recommending seeking professional advice on investments, I have always strongly advocated diversification across investment lines. Currently, the weaker dollar has affected not only the demand for goods and services in the U.S., but also the demand for stocks of U.S. companies. Remember, stocks are priced in U.S. dollars; the dollar has become weaker relative to other currencies, and increased purchasing power of foreign investors has also fueled the prices in the stock market. The chart below depicts just the activity of the Euro currency against the U.S. dollar over the last 12 months, yet you can see the volatility (very active) and the trend (mostly down for the dollar, until recently).

What does all of this mean to us as U.S.-based investors?

It is always important to be aware of "trends" in the stock market in particular. Once a trend begins, it typically tends to run for a period of time. One key to successful investing is to have some sense of the duration of a trend in order to take action in advance of a change; by following the movement of the dollar, we can better anticipate possible upcoming changes in a trend. Understanding that the decline in the relative value of the dollar against other currencies has fueled an upward trend in prices of commodities and stocks, and watching for the trend in the value of the dollar to change from downward to neutral and then to upward, we will have a sense of what to expect next in prices. Hence, the need to diversify in the interim, as we don't know exactly when these changes will occur. The chart above reveals a more than 10% swing in the dollar value against the Euro currency over the last 12 months; the move has been similarly relative to other currencies. The chart seems to indicate a small rebound currently. If the rebound is sustained for several months, it would appear that the trend is neutralizing and maybe preparing to reverse. Of course, if that is confirmed, based on historical precedence we would see a decline in asset values priced in dollars, including stocks and commodities.

 

©Patrick J. Catania 2013
The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances.