June 27, 2008

The Diminishing Purchasing Power of My Dollar
Miami Beach, United States

My dollar is a wimp.

Step outside of the United States for any period of time, and you'll be able to see its power diminishing, its dominance fading.

I hadn't really noticed for a long time—there was little reason to. Exchange rates were what they were, and only on the rare occasion did they seem to differ much from what they were published as in the guidebooks—some printed upwards of a decade ago.

I suppose it should be otherwise, but I think it took going back to the same location abroad several times over before I really started to notice the devaluation of my homeland currency. For me, that location was Thailand.

In 2005, I considered converting my savings from dollars into euros. Financial institutions like EverBank allow Americans to hold nondollar-denominated deposits in a bank account insured by the Federal Deposit Insurance Corp, plus the opportunity to expand beyond euro-denominated deposits and diversify across currencies.

I sought the guidance of my father, who advised against it, citing the monetary hit from the initial conversion and future conversions would be counterproductive. Naturally, the risk also comes in repatriating foreign currency into U.S. dollars. If the euro declines, I'd take a hit.

For me, everything costs about 35% more in Poland than it did two years ago

But as I look at the diminishing purchasing power of the dollar, I can't help but wonder if I made the right decision. From the perspective of a traveler spending savings earned a few years ago, it's getting harder and harder to travel on a shoestring.

For example, a typical dorm bed at a hostel in Kraków, Poland is going for 50 Polish zloty per night. Two years ago, that 50 PLN/night rate would've cost me about $15.50. But by today's exchange rate, the same bed at the same price would cost me $22.75 US dollars/night.

That's a big difference—one that's being echoed on a global scale.

So as I watch my currency continue to crumble, I feel fortunate that I'll be going to Eastern Europe now, as opposed to later.

Why Is the Dollar Losing Value?

This ABC News article touches on some of the points:

There are several reasons. First, there's the difference between the interest rate in the United States and the interest rates of other central banks around the world.

When the United States dropped its rate, other banks did not follow. Now the spread between the interest rate at the European Central Bank (home of the euro) and the Federal Reserve (home of the dollar) is smaller than it has traditionally been, and that has weakened the value of the dollar against the euro. Put another way, you would get a better interest rate return holding a euro than a dollar.

Second, central banks around the world have been diversifying their holdings away from dollars to euros, British pounds and so on. That means there are more dollars out there in currency markets available to purchase. More dollars floating around means diminished value.

What Effect Does This Have?

Look at the record-high price of oil. Even if the same amount of oil is being pumped out of the ground, since it is traded in dollars and the dollar has weakened, the price of oil has increased to make up for the lost value of the dollar, creating a sort of vicious cycle.

Oil-producing countries don't want to keep all the dollars they are getting for their oil, since it's worth less, so they are diversifying and converting their dollars into euros or other currencies. That pushes more dollars back out into currency markets, which in turn pushes down the dollar's value.

One analyst told ABC News that Russia used to have 90 percent of its financial reserves in dollars. It now has 45 percent in dollars, 45 percent in euros and 10 percent in British pounds.

What Does This Mean in the U.S.?

The news is mixed. It's good, because it makes what we produce here cheaper to sell in foreign markets, and that in turn spurs exports of our products around the world. That translates into more manufacturing and more jobs. For example, BMW and Mercedes Benz want to build cars in the United States, because they can do it cheaper in nonunion states than in Germany, where they'd pay labor and parts in euros, and then bring the cars to the United States, where they would be too expensive to sell at a profit.

But a weak dollar is bad, because it leads to inflation in this country. Imports from foreign countries will become more expensive, and in particular, oil will be more expensive. That puts pressure on businesses to increase prices for anything that uses oil or products that come from overseas. One benefit for American shoppers is that China has largely pegged its currency to ours, so that keeps the price of Chinese-made goods low and therefore, keeps a check on inflation.

U.S. Treasuries, Bonds, Mortgages, Stocks

What does a weak dollar mean for all that, and why should I care? If the dollar falls too much, foreign investors and banks won't be so interested in buying T-bills and bonds that keep the U.S. government and businesses humming. That's because the interest rate might not be enough to compensate for inflation. In other words, whatever is earned would be worth less money.

To attract buyers, the T-bills and bonds will sell for less and have higher interest rates. And since many mortgages are tied to these interest rates, that might mean mortgage rates won't drop anytime soon. Also, a weak dollar might scare away foreign investors who don't want to own stock in U.S. companies.

What About Foreign Investors?

Could there be a wholesale dumping of U.S. dollars by foreign governments and investors? Maybe. But that would be executing a sort of "nuclear option."

If China were to dump its reserves of dollars into currency markets, that would dramatically lower the value of the dollar. All those bonds and T-bills that the country holds would drop in value, as inflation would erase any gains from the investment. China would be less able to sell its goods to the United States because the dollar would be too weak, and Chinese products would be more expensive.

If Saudi Arabia were to call for oil to be traded in euros, "that announcement would be the end of the U.S. dollar," said Ashraf Laidi, chief currency analyst at CMC Markets. But he said that would never happen as long as the United States and Saudi Arabia are allies, and the U.S. continues to negotiate arms and other deals with the world's largest oil producer.

One blog posting I read on the subject made this entertaining remark:

I actually don't mind that much. My student debt is huge, my mortgage is six figures, so if the dollar becomes worth as much as the Turkish Lira, what do I care? I can’t wait until a loaf of bread costs $100. I'll be able to pay off my debt with a half a day's pay.

Comments:

The United States

Roosh

July 4th, 2008

Okay lets do the math. Say you put $1,000 in the brazilian Real on January 1, 2008 when it was 1 dollar to 1.77 reals. After a 1% conversion hit ($10) you would get 1752 reals. On June 1 you decide to pull out when 1 dollar was equal to 1.62 reals. Converting back and account for 1% conversion that gives you that gives you $1070.

$70 profit off $1000 in six months gives you an APY of 14%, above current 2-3% rates that internet savings accounts give you. But wait, there's more…

3 month CD's for the Real gives you 5% APY

So let's take a medium case scenario where there is no change in currency rates in the CD during the 3 month cd. That means you get 3% after the conversions. Because i don't see the dollar going up anytime soon, it seems like a low risk bet to me. I'm not trying to get rich off currency trading, but i want to preserve what I have. Holding dollars seems like a big gamble right now

The United States

Bob L

July 7th, 2008

You are missing another point. The economic status of the country you are visiting could be improving. Using Poland as an example: My dad went to Poland a number of times surounding the fall of the iron curtain. I went once also. The differences in the purchasing power of the US$ over time was incredible. For some things it was ten times more expensive after only a few years. In this case, it was mostly an improving economy in Poland that hurt that purchasing power. I suspect that is a partial contributor now, along with the weakening $.

Bob L

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