If you've been following financial news at all during the last few months, you know that the U.S. Dollar is weak . . . it is weak compared to historical levels versus other currencies, and continues to weaken.  Why, then, would Joseph Quinlan, chief market strategist at Bank of America say "The dollar is in a quasi-sweet spot"?  And why would former Federal Reserve economist, Sophia Drossos, state "It doesn't seem like it's in the interest of the U.S. Treasury to arrest the decline of the dollar"? (Bloomberg News)

It's because they understand that a weak dollar can actually do a lot of good things for our economy.  And you can benefit too.  But truly the interaction of currencies is like the mind of a teenager.  It's complicated, capricious, and often ethereal.  Once you think you understand it, things change and new influences are at play.  Both can leave you muttering to yourself.

However, grasping why a falling dollar may not be bad for you, us, or the country is certainly worth a shot in this Commentary.  First, it is important to understand that the U. S. dollar is a commodity, just as other world currencies are.  It is bought and sold by people all over the globe, and they purchase U.S. dollars with their own currency.  Why would they want to buy U.S. dollars?  Because they want to buy U.S. products, including financial ones, such as U.S. Treasuries . . . and they need U.S. dollars to do this.  We buy foreign goods by trading U.S. dollars for the local currency, whether it is Yen, Euros, or Lira.  Most of the money trades electronically on the Forex Market (Foreign Exchange Market).  Prices of currency fluctuate on this market due largely to the law of "supply and demand".  As an example, if German investors saw an opportunity in the U.S. they really wanted, they might be willing to pay more Euros to get the dollars to buy it . . . and in this case the dollar would have strengthened against the Euro, and the Euro weakened against the dollar.  This goes on all day, 24 hours per day.

This is much more complex than we've made it out to be, but just know that all major currencies are commodities with no fixed prices relative to each other.  They are worth what people and institutions think they are worth at any given moment.  And the dollar is not pegged to gold anymore; it is worth what opinion says it is worth.

But what affects people's opinion of the value of the dollar?  Many things including interest rates, inflation, our overall monetary policy, financial markets, the domestic economy, and trade and government surpluses and deficits.  Generally, the dollar will strengthen relative to other currencies if we have higher interest rates (people will want to buy dollars in order to purchase our higher yielding bonds and notes); the dollar is also buoyed by the perception that our stock market is strong, and that the "Fed" has a handle on things; buyers of dollars like a strong U.S. economy; low domestic inflation means that the dollar purchased with Euros or Yen or Lira will keep it's purchasing power longer. 

Conversely, the dollar will weaken when foreign investors think they can get better rates investing in bonds and notes in countries with higher interest rates than the U.S.; if inflation is high in the U.S., the dollar that is purchased won't go as far here, and is not considered as valuable; when our financial markets are weak, countries do not want to buy dollars to invest them in our markets; and a slowing economy will also hurt, as foreign investors will not want to invest here.  We'll assume you get it then . . . the value of the dollar shifts for lots of reasons.

What does this mean for you?  And why were Mr. Quinlan and Ms. Drossos OK with a weak dollar?  Well, it can be very good for U.S. manufacturers.  A weak dollar means that a strong Euro (for instance) can buy more of those U.S. dollars . . . to purchase U.S. goods here.  It makes our products more attractive to foreign purchasers.  And when people buy more of our goods, because their currency is stronger, it reduces our trade deficit.  This is a good thing.  As a matter of fact, in the second quarter of 2007 we saw the biggest trade deficit improvement in 20 years (shrinking the deficit by $14 Billion) . . . exports were up over 11% from a year earlier. The Port of Long Beach (a major shipping port) saw a rise in exports of over 34% in August, compared to a year earlier.

This is welcome news for an economy that is still working through a liquidity crunch and a housing slump.  It is estimated that trade added 1.3% to growth in the second quarter (the most in 11 years), and it was the first time since 1991 that exports contributed more than consumer spending to the economic expansion (source, International Herald Tribune).  All of this because of a weak dollar.  This is why we don't see the President or Treasury Secretary Paulson wringing their hands.

And currency exchange has a dramatic affect, often very positive, for those of you who hold foreign investments.  If the manager of your investment wants to buy a foreign stock, she pays dollars for it with the local currency.  Then, when she sells the stock, the proceeds are in local currency that is converted back to dollars.  Think of a case where a 10 Euro/share stock was bought when the dollar was strong, and you got 1.2 Euros for each dollar.  100 shares only cost you about $840 dollars.  Three years later this foreign stock is sold when the Euro has strengthened against the dollar . . . a dollar will now only buy 0.82 Euros.  This is quite good for you.  Forgetting any appreciation of the stock price itself, if you just sold the stock for 1,000 Euros you paid for it, these would now convert to over $1,200 in U.S. dollars.  The stock originally cost you $840 U.S. dollars and you got back $1,200.  You made over 40% on the currency movement alone!  This is an illustration only, but you can see how dramatically this can affect your foreign investments.  It is complex and volatile however, which is one reason we buy foreign investments with pros managing the decisions. 

Understanding how all this currency movement works seems like looking at a Seurat painting (the guy who painted with dots) from a foot away.  It's too busy, and makes no sense.  Just take a couple of steps back, though, and things are better . . . you still know its very complex, but now you get the general idea.

We have taken a couple of steps back and think our dollar looks fine, weakened though it may be.  Sometimes weak is good.

Craig Pulliam andMichael Comstock are CERTIFIED FINANCIAL PLANNER ™ professionals practicing at 112 Westwood Place, Suite 310 in Brentwood, TN. They own Premier Asset Management and are registered representatives and investment adviser representatives with/and offer securities and advisory services through Commonwealth Financial Network:

 A Registered Investment Adviser, Member FINRA www.finra.org, SIPC www.sipc.org.

They can be reached at 615-777-2125.

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