Saturday, November 06, 2004

Falling dollar: who wins and who loses

I was asked about who benefits and who loses from the falling dollar. Lets get one thing clear first, devaluing currency and low interest rates do not go hand in hand, this relationship will cease to exist sooner or later. The falling dollar will evenutally lead to higher yields being demanded by foreign buyers of our debt. Chinese, Japanese, German investors will not accept 4% yield while the dollar losses 10%-15%, there is no money in it for them in that scenario. If you remember, the dollar did gain some ground when the fed started raising interest rates. Foreign buyers were optimistic about earning higher yields and wanted to buy dollar-demoninated fixed income instruments. That didn't last for long because Bush administration never really pushed for a strong dollar. Weaker dollar benefits U.S. companies in selling their products overseas and helps with creating demand for real assets like real estate (assisted by cheap money).

Devaluing dollar does not benefit the equity markets or the fixed income markets. Remember the 1987 market crash was primarily triggered by spike in interest rates driven by the falling dollar. Interest rate sensitive industries are at risk; lenders who have been more than generous to help spur the real-estate boom, Industrials that depend on raw materials purchased overseas, and car makers. Car manufacturers will be hit twice as hard since they buy steel in foreign markets (usually dollar demoniated and when dollar depreciates it costs them more), also car makers cannot create demand by offering zero or near-zero percent car loans. Winners in the devaluing dollar environment will be commodities and exporters.


Blogger Roger Nusbaum said...

Good stuff. I know a lot of people that mange money (not in a name dropping way but in a seeing different styles way) and the number of people that run money that pay no attention to this stuff is astounding. It is certainly possible that the dollar decline will have little consequence to the US bond market and stock market and everything else you cite but to ignore it seems almost malfeasant.

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