Happy new year! Somewhere among the new-year vows of weight loss, self-improvement, and advancing one's education, there are inevitable thoughts about money; how to make more, how to save more, and how to better invest the hard-earned dollars.
Unfortunately the outlook for the dollar remains poor for 2007 and there is fear that it will continue its slide. Some evidence of that can be seen through the stances taken by a few central banks. Iran has indicated that it is moving away from its dollar reserves, gradually replacing those with euro-based instruments. UAE is also boosting its euro reserves considerably while paring its dollar holdings. Before you dismiss these moves as political and confined to a few countries, you should keep in mind that no country would sabotage its own economy deliberately even if it is at odds with the United States. And UAE has been an ally of the US for a long time.
The point is that these countries have seen that holding dollar reserves is not in their best interest. As the values of their stash keeps shrinking they have become increasingly concerned and are now taking steps to correct their lop-sided positions in the dollar. True, these countries by themselves may not have a considerable impact on the dollar. What is disconcerting, however, is that many other central banks are mulling over the same issue and might soon begin to dump their dollar reserves. If a selling frenzy ensues, even a mild one, it could have devastating effects on the dollar.
So what does that mean for the average American citizen? Quite a bit actually. First off, if a dollar crash begins to look imminent, the federal reserve would have no choice but to lift the interest rates (perhaps considerably) to defend the currency. Why defend the currency? For one thing to protect the consumers. Those cheap Chinese imports would no longer be so cheap if the dollar keeps on falling. A falling dollar means more expensive products here in the US. But what about American-made products? The US is no longer the manufacturing powerhouse it once was, but even for the domestically made products other regions of the world will look far more lucrative than the US market. The US is a capitalist market. That means that whoever pays the highest price, gets to buy the products. With the weakened dollar, the local consumer will have to pony up a lot more money to compete with the ones abroad.
This is already happening. There was a news item a few days ago regarding milk and dairies price hikes for the new year. One reason given was the elevated levels in foreign purchases of dairy products, no doubt due to the cheaper dollar. Recently New York City has been running advertising campaigns in foreign countries highlighting the cheap dollar as a means to visit the city more cheaply. I can imagine that hotels, restaurants, bars and taxi cabs might raise their prices as tourists flush with dollars bought cheaply in their own countries, would be less resistant to higher prices.
The higher interest rates set by the Fed to defend the dollar might stanch the bleeding a bit, but not before its repercussions are felt throughout the banking industry in the form of higher borrowing costs. Yes, that means higher mortgage rates, higher credit card interest rates, and higher business loan interest rates, which will ultimately contribute to higher prices in a continuous cycle.
If you are worried, as I am, rather than buying euros and stuffing them under the mattress, it might make sense to invest in some reputable international funds for 2007. This will provide a bit of international exposure with good returns if the dollar malaise continues to worsen.