The sinking dollar

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It takes more than $1.40 to buy one euro today. It cost less than $1 as recently as late 2002. A Canadian dollar is worth just about exactly a US dollar--a parity not seen since the 1970s. Should Wise Bread readers care? If so, what should they do?

Higher prices for imported goods

The most obvious reason for US readers to care would be if a lower dollar led to higher prices for imported goods. When exchange rates make the dollar worth less, it seems obvious that it would take more dollars to buy all the stuff imported for sale in the US. The fact is, though, prices are generally set at what the market will bear already and those prices don't change very quickly in response to changes in the value of the dollar.

The most immediate effect of of lower dollar is higher costs for importers--higher costs that they largely can't pass on to consumers. The result of that is a profit squeeze on the importers. Faced with such a squeeze, they do their best to push back at both ends--trying to get lower prices from their suppliers and trying to push higher prices onto their customers. It's hard to know to what extent they're being successful--companies keep that sort of data secret--but there's been no sign of a spike in prices for ordinary imported consumer goods.

Higher prices for raw materials

The price of oil, quoted in dollars, has risen for most of the year. Looked at in euro terms, though, the change is less stark. A $60 barrel of oil at the end of last year would have cost €46 versus €57 for an $80 barrel today--a 22% change in euro terms versus a 33% change in dollar terms. The price of oil really is up, but not as much as the price in dollars might suggest.

Oil isn't the only raw material, of course. Prices of most basic materials--iron, gravel, lumber and so on--are all up in dollar terms. Like with oil, this is partially a real increase in prices, and partially just an effect of the falling dollar.

(Given the high oil prices, the price of gasoline has been surprisingly low, at least in the US. Enjoy it while it lasts.)

Expensive travel

If you're an American traveling overseas, you will definitely notice the difference--everything will cost more. Without the buffering effects of importers and retailers who are willing to sacrifice some of their profits in the interests of maintaining market share or customer relations, you're stuck paying the local price.

People whose income and savings aren't in dollars

A good number of Wise Bread readers live in countries other than the USA. Of course, where you live doesn't matter so much as where you earn your money and how it's invested.

To the extent that your wealth and income are in something other than dollars, the decline in the dollar provides some initial benefits--commodities priced in dollars are cheaper, as are goods and services from US sources.

Longer-term, though, the benefits are less clear. Those foreign manufacturers benefiting because many commodities are priced in dollars, are in many cases the same ones taking a profit hit to keep selling to US importers. For those products where the US is still an exporter, the US firms have a growing exchange rate advantage--they can cut their price to foreign buyers and still bring home just as many dollars as before. If you're an owner or an employee of a firm with a US competitor, the lower dollar may hurt as much as it helps.

Longer term

Last week's Economist makes the point that, "It is how steadily the dollar is falling that counts, not how swiftly." However much importers and retailers try to buffer the changes from the falling dollar, over the longer term the exchange rate matters, and there are plenty of doomsday scenarios that play out if people in other countries decide that they'd just as soon not hold dollars anymore. Even a small shift in the preferences of the people and institutions that have been lending money to US borrowers could push the dollar down very quickly.

The only way to retain those investments, if people start to move money out of the dollar, would be to raise interest rates sharply. But with the US economy already suffering from the subprime lending crisis and the resulting financial squeeze, the flexibility for the Fed to do that is minimal--indeed, the Fed just lowered interest rates last week.

What to do?

Since we don't know which way exchange rates will move in the future, it's hard to provide any slam-dunk suggestions. Having some international diversity in your investments is always wise, but moving out of the dollar just as it hits record lows is not necessarily the best strategy. (You're too likely to find yourself unprofitably buying high and selling low.)

If it were easy, probably the best thing to do would be to arrange to have some international diversity of income. It would be very nice if everyone had 15% to 20% of their income in foreign currencies so that it would grow when the local currency fell and vice versa--adding a stabilizing influence to household income. Sadly, that's not really practical for most people. Working for a multinational corporation provides a tiny sliver of the same benefits, but most of the upside will probably go to investors rather than employees.

Still, as long as you have your income in the local currency, you can at least take advantage of the buffering effects mentioned earlier. The worst situation is to be living in a country with a rising currency while earning your income from a country with a falling one. (The situation of Americans living abroad just now.)

For most Wise Bread readers, there's probably no benefit to taking any sudden or major actions just now. Maintain or gradually work toward an internationally diversified investment portfolio. Consider trying to develop some foreign-source income. Over the medium-term, arrange to live in the same country that the majority of your income comes from. If you can do at least a couple of those things, you'll be fine.