Tuesday, September 9, 2008

The dollar has seen its lows

This is arguably the best measure of the dollar's value vis a vis other currencies. It's calculated by the Fed, and takes into account the importance of other currencies based on the amount of trade we have with them. It also takes into account inflation here and in other countries. As the chart suggests, the dollar recently hit a low which it has only hit two times before. Chartists would call this a "triple bottom." The dollar has been extremely depressed because the news here has been about as bad as could be expected, while, until recently, the news from overseas was reasonably good. Now the dynamic has shifted. The news here is still bad, but as I've been arguing we may have seen the worst. Meanwhile the news from overseas is not so great anymore. Europe is slowing down, emerging market economies are suffering on the margin from lower commodity prices. And the US election is creating surprises by the day: just last weekend Obama admitted that higher taxes wouldn't be good for the economy, and essentially said that higher taxes on the rich wouldn't be a priority unless the economy is doing a lot better. That brightens the prospects for the US economy and is undoubtedly one of the reasons the dollar is doing better. What this means for investors is clear: avoid investing in foreign bonds or stocks unless the currency risk is hedged. That's not always the case with a lot of mutual funds. Those same funds have enjoyed spectacular returns in recent years, mainly because the dollar has been falling. Now that the dollar is rising those funds are going to be facing a big drag as foreign currencies decline in value.

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