The dollar will probably fall in the second half of the year: what does that mean for you -- the typical U.S. investor?
The dollar Friday was on-pace to record its biggest drop against Japan's yen, to about 79.05 yen, and had given back about one-half its weekly gain versus the euro, to $1.4103, and greenback's dip is not a surprise, given recent U.S. fiscal and monetary policy developments.
First, and most significantly, President Barack Obama and Congressional Republicans have not yet agreed on a deficit reduction total as part of a plan to raise the U.S. Government's debt ceiling, and the nation is quickly approaching the Aug. 2 date when it runs out of money. Technically, the U.S. Treasury will lose its legal authority to borrow money, and if it does, the unthinkable could occur: a U.S. Government default on its debt.
If a default occurs, institutional investors (IIs) will view U.S. debt as more-risky, and that will push up U.S. borrowing costs, among other destructive and economically counter-productive consequences. Some investors will also sell or 'dump' U.S. debt, and this will act as a downward pressure on the dollar.
Second, U.S. Federal Reserve Chairman Ben Bernanke, in testimony this week on Capitol Hill, said the Fed concurs that the U.S. economy is growing too slowly and that the U.S. unemployment rate remains at a level the Fed considers unacceptable: 9.2 percent. Translation: the Fed is not likely to raise short-term interest rates at least for the next three months, and probably through the end of 2011. That means investor money will flow to higher-interest-rate currencies, such as the euro and the Swiss franc -- putting additional downward pressure on the dollar.
But what should you, the typical U.S. investor, do? Should you sell some of your U.S.-based investments now?
If you plan to retire in a year, you may want to sell a portion of your dollar-denominated bonds. Or, if you're convinced that the U.S. economy is headed for even deeper trouble, such as a double-dip recession, cycling out of bonds and stocks, and in to safer investments, would be the tack.
However, if your investment horizon is longer than a year, the prudent tack is to stay-the-course: if the two political parties in Washington can ever get their act together and pass a substantive, enduring budget deficit reduction package with a debt ceiling increase, better days are likely ahead for the dollar and U.S. investments.
That's because, assuming a debt deal, the Fed will maintain its investor-friendly, loose monetary policy, in order to increase U.S. GDP growth, earnings growth, and job creation. And as profits rise, dollar-denominated investments will become more attractive, and the dollar will likely strengthen versus the world's other major currencies.
Therefore, if your investment horizon is longer than a year, keep this in mind: the dollar may be down, but it's not out.