It sounds pretty grim, for America and for investors. However, cynical as it may be, we weren't able to stop George W. Bush, but at least we can try to profit from his foolishness. We aren't dogmatically bound to the fictions of "deficits don't matter" or the idea that the economy is driven by the wealthy. So what do we do if we have little faith in the stock market and find few bargains there, but we want returns on investment better than current interest rates offer? One strategy, which may or may not work, is to sell the American dollar short.
What do I mean by selling the dollar short? Normally, when you invest, you buy something, wait for it to increase in value, then sell it. When you sell something short, you sell it, wait for it to drop in value, then buy it back at the cheaper price. Dollars are something we already have in our bank and investment accounts, and we can sell them for other currencies. If the value of the dollar drops relative to the currency we bought, we can use our foreign currency to buy back more dollars than we sold. If the value of the dollar rises, however, we lose money. To start with, let's look at how the euro and the yen have performed against the dollar over the last five years: (from MSN Money Central)
The Yen has been flat for a lot of reasons, including chronic economic malaise in Japan and its government's desire to keep its currency low to promote exports. Notice that the Euro now buys almost 50% more dollars than it did in January 2002. Anyone who bought Euros three years ago got a huge return on their investment. The big question is, will this trend continue, will the Yen follow the Euro's rise, or will the dollar increase in value instead? The valuation of currencies against each other is complex, but it pretty much boils down to supply and demand. Here are some of the big factors involved:
- Economy: a strong U.S. economy encourages foreigners to invest in our economy and buy dollars in the process
- Interest rates: if interest rates are high here compared to other countries, foreigners are encouraged to buy interest earning U.S. investments
- Trade: a high or increasing trade deficit means there is a lot of supply of dollars overseas, which lowers their relative value
- Budget: the same effect as trade: a budget deficit means we are demanding other currencies to buy our bonds, thus raising other currencies relative to ours
- Inflation: if a currency is experiencing inflation, the value of that currency drops.
So what am I doing? I am partially invested in Euros. In spite of everything going against the Euro, the dollar's value relative to it is largely a function of the U.S. economy. Basically, it all boils down to whether you see the glass as half full or half empty: if you are an optimist about the U.S. economy, keep your money here. If the U.S. economy weakens, the dollar is really screwed regardless of what is happening in Europe and Japan. I'm a pessimist right now (like Jerome a Paris), since I see a lot of potential downsides to the U.S. economy, but far less upward potential relative to where we are right now. Since I am a fan of Vanguard and index funds, I've invested in a European Stock Market index fund (VEURX). I figure I get the investment in Euros that way, plus any benefit from growth as the European economy wakes up. Others may suggest a bank account in Euros - I'm not very familiar with how that's done, but advocates of that approach can leave details in the comments. UPDATE:: Commenter Impasto says you can get bank accounts in other currencies at Everbank.
DISCLAIMER: This is risky, with greater potential upside and downside than more conventional investments. Believe me at your own risk! Nobody (not even Vanguard) is paying me anything to mention their products, but I own VEURX.
Everyone is encourage to submit their own Investment Club entries, or this series will soon die out! I don't know that much on my own!