U.S. Dollar: In Danger As Reserve Currency.

Corporate American Sweating Regulation As Capital Finds Home Elsewhere

The U.S. Dollar is nearing a multi-year low, as measured by the Dollar Index. The common wisdom suggests that the status of the dollar is based on economic fundamentals. Yet, there is data that suggests that beyond the slowing economy, the long term trend and the increasingly dangerous of the dollar is stemming from policy decisions made by Congress and by the White House.

According to Investor's Business Daily: "a growing chorus of officials and executives are howling that the U.S. is losing ground to more nimble markets like London and Hong Kong." Indeed "After decades out front, a report says the U.S. hobbled itself with overly strict regulation while the spread of globalization and technology helped the rest of the field play a stellar game of catch-up."

At the same time, the Wall Street Journal reported: Treasury Secretary Henry Paulson "has chosen to follow in the footsteps of his predecessor, John Snow, by acquiescing as markets pull the dollar lower. "

The logic of Paulson's alleged push for a weaker dollar is twofold: "a weaker dollar could help the U.S. deflate its ballooning trade deficit by making American goods cheaper abroad and foreign goods pricier for Americans. It also could help Mr. Paulson fend off what he considers an alarming rise in protectionist sentiment."

The problem with that argument, although it holds some water, is that the world is a different place in 2006, than it was in the early 1990s, the last time a Bush administration was accused of "dollar bashing."

In the post 9/11 world, the markets move faster, and there are clearly more places to put money to work with a fairly good rate of return, at least in the short term. Aside from Europe, there is China, as well as other so called emerging economies like India, Brazil, Chile, and Mexico.

Few of these countries have the same kind of regulatory environments that Sarbanes-Oxley has created.

The Evaporating IPO Market

In case no one has noticed, the last bull market was fueled by a huge runup in IPO issuance in the U.S. Sure, the dot-com bubble ended badly. But the mechanism for capital creation and distribution in the U.S. was a well oiled machine, albeit one that wasn't always honest.

But times have clearly changed. According to Investor's Business Daily "just 5%" of the total money raised by IPOs in the world "was raised in the U.S. In 2000, the figure was 50%."

It doesn' take a whole lot of cleverness to figure out that money that would have made its way to the U.S. is now going elsewhere.

The situation is more complex than meets the eye though, as IBD notes that the only reason more firms aren't leaving U.S. stock market listings, is that it would be too expensive to leave due to the fact that "that U.S. regulations make it tough to leave."

And it's not just IPOs. According to Investor's Business Daily: "As recently as 1989, 90% of the world’s commercial paper was issued in dollars. Now the number is less than 25%, according to the Bank for International Settlements."

The Trading Angle

One way to make money from a falling dollar is to bet on the contination of the trend.

Our dollar timing model is currently short the dollar via the Profunds Falling Dollar mutual fund (FDPIX).

A mutual fund is a convenient way to capitalize on the overall trend of the currency markets, without having to sweat out the details and the intraday volatility of the sector.

Another way is to use interational exchange traded funds, such as the ishares Germany Fund (AMEX: EWG), see below.

When trading currencies, though, directly or indirectly, investors should be ready to respond quickly to external events, both economic and geopolitical.

For more on trading currencies read Chapter 11 in "Futures And Options For Dummies".

Conclusion

The dollar remains the centerpiece of the global financial system. But it is clearly facing some very serious competition.

If the dollar continues to fall, though, there will be some repercussions.

The White House is hoping that a weak currency will spur demand for less expensive U.S. goods.

The problem with that argument is that it's a 20th century view, and may not be applicable to an increasingly global economy, where the Euro, the Yen, and other currencies are starting to have more influence.

Perhaps one of the most negative legacies of the Bush II era might well be the fact that the U.S. dollar might have suffered irreparable damage, and that its exclusivity as the world's reserve currency may have been permanently, or at least semi-permanently damaged.