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The U.S. Dollar and the Thief in the Night

Wed, Sep 12 2007, 10:20 GMT
by Online Trading Academy Team

Online Trading Academy

By Edward Ponsi

You are an American. You work hard, and you save your money. Your investment portfolio is in good shape, and your house is still worth considerably more than you paid for it. Your net worth is greater than it ever has been. Yet somehow, you don't feel as wealthy as you imagined that you would at this stage. The money that you have doesn't seem to go as far as it should. It's almost as if someone or something is draining your wealth while you sleep at night.

Why aren't we as wealthy as we ought to be? Is it China's fault? Is it the price of oil? What if I told you that the reason why your wealth is eroding is due to the weakness of your currency?

It is crucial that every citizen of the U.S. understand the true nature of our current predicament. The U.S. Dollar has been losing value steadily for years, and with Ben Bernanke and the FOMC poised to lower interest rates on September 18th, possibly the first in a series of rate cuts, the greenback is poised to take yet another beating. Lower interest rates will drive capital away from the U.S. and toward countries that offer higher yielding investments, resulting in a weaker currency. The U.S. Dollar Index (USDX), which measures the buck's performance against a basket of currencies, has just fallen to another new low. Here we see the decline of the dollar for the decade so far (see figure 1).

Figure 1: U. S. Dollar Index (USDX) reaches a new 15-year low. Source: FX Street.com

So why should the average American care about the weakness of the U.S. Dollar? Well, if you've spent your entire life accumulating U.S. Dollars, and you own a house that is valued in U.S. Dollars, and you own an investment portfolio that is valued in U.S. Dollars, then you are personally affected by this. It might not be obvious to you in your day-to-day life, but the effect of a weak dollar sure becomes apparent once you travel overseas. If you travel to the U.K., you may find yourself paying the equivalent of $10 for a Happy Meal. Given the circumstances, fewer and fewer Americans are choosing to travel outside of the U.S.

But the consequences of a weak currency go far beyond international travel. While many in the U.S. face the possibility of losing their homes over the next few years because of the subprime mess, some of my friends in the U.K are considering purchases of property in the U.S. From their perspective, U.S. property is getting cheaper by the day because of the weak dollar. Imagine that - people from Europe and Great Britain can afford to buy U.S. homes, but many Americans can't. Welcome to the world of the weak dollar.

Now let's take it one step further; not just property, but all U.S. assets are now less expensive to folks from outside the U.S. If the greenback continues to slide, some U.S. companies may become easy takeover targets for those who possess a strong currency. Since it will cost less for European and U.K. companies to employ Americans, we may now become "cheap labor" for companies based in these countries. Who knows, at the rate things are going, someday people in other countries will complain about the outsourcing of their jobs to Americans. Sure, we want jobs, but do we really want to become a third-rate country in the process?

How much has the price of oil really gone up? Sounds like a silly question, doesn't it? But that's only because we are looking at one side of a two-sided equation. We know that the price of oil has risen dramatically, but consider this - the real price of oil has not increased as dramatically in Canada as it has in the U.S. How can this be? The price of oil has more than doubled since early 2004 (see figure 2).

Figure 2: Crude oil has more than doubled in price since early 2004. Source: Saxo Bank

A more precise way to put it would be that the price of oil as measured in U.S. Dollars has doubled during that period of time. In early 2004, one U.S. Dollar was worth 1.40 Canadian Dollars (see figure 3).

Figure 3: U.S. Dollar was worth 1.40 Canadian Dollars in early 2004. Source: Saxo Bank

So let's do the math; if one barrel of oil was worth $37 USD in early 2004, and one U.S. Dollar was worth 1.40 Canadian dollars at that time, then one barrel of oil was worth about 51.8 Canadian Dollars in early 2004 (37 x 1.4 = 51.8).

Right now, a barrel of oil costs about $78 USD, and one U.S. Dollar is worth 1.05 Canadian Dollars. So, we could say that one barrel of oil is now worth about 81.9 Canadian Dollars (78 x 1.05 = 81.9).

Wait a minute! The price of oil has skyrocketed since early 2004, from $37 to $78, an increase of over 100% for those who live in the United States. But when measured in Canadian dollars, the price of oil has risen from 51.8 to 81.9 - a gain of less than 60%. Sort of makes you wish you lived in Canada, eh? The same is true for many countries whose currency has strengthened vs. the dollar.

So who benefits from the weak dollar? Well, U.S. corporations that do a substantial amount of business overseas are the primary beneficiaries, because our soft currency makes their products cheaper to overseas buyers. Export driven U.S. companies are raking in the profits while imports are becoming more expensive. They make more, and we pay more. So the U.S. trade deficit must be improving, right? Not really. Sure, exports are at an all-time high, but so are imports. The U.S. Trade Deficit for August is projected to be $59 billion - not an all time high, but not far from it, either.

So get ready, America. Get ready to pay more and receive less. And if the dollar continues to fall, the situation will only get worse. That is, unless we decide to put a stop to this madness.

Here is the bottom line - even if we have the same amount of money as before, we are getting poorer every day. This is not a political issue; it is a quality of life issue. A weak dollar will affect the quality of life for us and for our children for years to come. It's time for people in the U.S. to wake up and scream about it. Let's catch that thief in the night before it steals even more of what we've worked so hard to build.

Have a question about Forex trading? Send an email to eponsi(at)tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

Published on  Wed, Sep 12 2007, 10:21 GMT