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How can I protect myself from a falling U.S. Dollar?
With such large international holdings of U.S. dollars, the U.S. financial situation has become less and less flexible since 2001, when we had a large budget surplus and were much less dependent on foreign capital. As the result of the growing twin deficits, the U.S. economy is less resilient. You may want to consider taking steps seeking to mitigate the impact of the potential further fall of the U.S. dollar as it relates to your portfolio. But how? We shall evaluate different strategies and what their pros and cons are; note that this discussion cannot be considered complete and is not to be considered investment advice as every investor’s financial situation is different:U.S. stocks
Many U.S. corporations have sales and expenses internationally, providing a “natural hedge.” However, you are exposed to all the risks associated with stocks. Should the dollar be under serious pressure, stocks may be negatively influenced.
U.S. real estate
“Hard Assets” historically do well when a currency is weak or we have inflation. However, the tremendous leverage in U.S. real estate makes the market very vulnerable to higher interest rates or lower purchasing power.
Bond funds
Bond funds can lose value in a rising interest rate environment as an inverse relationship exists between prices and interest rates. Ultra-short funds and money market funds try to minimize that risk. U.S. Bond funds provide no shielding against a decline in the U.S. Dollar.
When evaluating international bond funds, evaluate whether they seek or try to mitigate the currency risk. To the extent international bond funds are successful in mitigating currency exposure, you do not get the desired currency exposure. In other words, if you believe the dollar will weaken further, you may want to consider a bond fund that does not hedge its currency exposure, i.e. seeks the currency risk.
Separately, if international bond funds have a long duration, i.e. hold longer-term bonds, you are again exposed to the risk of rising interest rates.
International stocks
International stocks or stock funds provide exposure to foreign currencies. However, most large international firms heavily sell to the U.S. consumer. While intra-Asian trade and intra-European trade are strengthening, international firms are likely to suffer should the U.S. consumer decide to reduce his or her spending.
Asian currencies
The Merk Asian Currency Fund invests in a basket of Asian currencies.
As we have explained in the section on what has caused the U.S. dollar to fall, Asian countries have traditionally had an interest in keeping their currencies weak for the sake of keeping exports to the U.S. at competitive prices. This has lead to Asian current account surpluses as the flip side of the American current account deficit. Fueled by a flood of exports from Asia to the U.S., Asian economies have amassed immense currency reserves. Traditionally Asia has invested a great portion of these by buying U.S. dollar denominated assets. However, as the U.S. economy weakens, foreigners may be less inclined to buy dollars to finance the U.S. deficit.
The Merk Asian Currency Fund focuses on currencies that may not be able to resist the pressure to allow their currencies to appreciate versus the U.S. dollar. Currencies that will be considered for inclusion include, among others, currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Phillippines, Singapore, South Korea, Taiwan and Thailand.
A portfolio of hard currencies with a gold component
The Merk Hard Currency Fund focuses on countries that, in our assessment, pursue sound monetary policies. A sound monetary policy creates an environment that fosters price stability. Note that this definition does not explicitly state growth as an objective, as price stability provides a basis for long-term growth. Politicians tend to like to see an emphasis on growth in monetary policy, an important reason why central banks should be as free of political influence as possible.
Our world is not black and white, and it is in everyone’s interest that the U.S. economy, and with it the U.S. consumer, is doing well. There will always be political pressure on central banks; some countries are better than others at managing these pressures.
The Merk Hard Currency Fund adds a significant gold component to its portfolio; gold is real money, the one “currency” that has intrinsic value, unlike fiat currencies that are “merely” backed by the full faith of a government. Currencies that will be considered for inclusion include, amongst others, the Euro, Swiss Franc, Canadian and Australian Dollar.
You may want to evaluate whether you want to gain exposure to hard currencies from countries with strong monetary policies with the ease of investing in a mutual fund. This enables you to diversify your portfolio with the objective of reducing the negative impact to your capital against a decline in the dollar.
For in-depth analyses of further factors affecting the dollar, please read the Merk Insights and subscribe to our newsletter.
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