Diversifying into Other Currencies
Get some tips on how to hedge against a falling dollar.
Today’s topic is diversifying into other currencies.
A listener named Dave e-mailed me with this question:
How is the U.S. dollar valued on the international market? Why does the value fluctuate? And more importantly, why is the U.S. dollar now in a free fall?
I’m a U.S. citizen living in New Zealand. I often transfer funds from the States to New Zealand. With the value of the dollar falling (which is correlated to the New Zealand dollar’s rise), I experience a monetary disadvantage with each transfer.
Thanks for the questions, Dave.
The Declining Dollar
The U.S. dollar is falling and it’s especially noticeable to U.S. citizens traveling or living outside of the United States. Measured against a trade-weighted basket of other currencies, the dollar has lost a quarter of its value since 2002 and 6% since August. When the dollar falls relative to other currencies, the prices of imports in the U.S. go up, and the prices of U.S. exports go down, creating more demand for U.S. goods that are sold overseas. A weak U.S. dollar means that your money doesn’t buy you as much when you’re traveling or living abroad and converting U.S. dollars to other currencies.
A friend of mine from Ohio who’s living in Oxford, England recently e-mailed me to say how much more she would be enjoying life there if things weren’t so much more expensive than what she’s used to. A weak U.S. dollar can mean paying $5 for a coffee in Paris or $100 for a dinner for two in Auckland. Ouch!
For the most part, currencies aren’t fixed, but fluctuate or float relative to one another. This has been the case since 1971 when President Nixon ended the gold standard for the dollar. From 1944 to 1971, the Bretton Woods agreement was in effect, which fixed the U.S. dollar to gold and other nations’ currencies to the dollar.
Why Is the Dollar Falling?
The U.S. dollar has been going down for a number of different reasons. One key reason is that the Federal Reserve has been printing more money and expanding the money supply, which dilutes the value of existing dollars.
So how can you protect your savings from eroding because of a declining dollar? There are several things you can do.
Diversifying into Foreign Currencies
One thing you can consider doing is putting a portion of your savings into a foreign currency that’s stronger than the dollar. By diversifying into other currencies, you can reduce your risk and exposure to a declining dollar. If you convert a portion of your savings from U.S. dollars to, say, euros, and the dollar declines relative to euros, you come out ahead.
But diversifying your savings into other currencies isn’t without risks. If you put a portion of your savings into euros and the U.S. dollar were to go up relative to the euro, you’d lose money when converting your savings back into U.S. dollars. Also, keep in mind that other currencies are fiat currencies like the dollar and can lose value over time as their central banks print more money. Nonetheless, diversifying a portion of your savings into other currencies can be a way to reduce overall risk.
A U.S.-based bank that lets you keep your savings in the currency or currencies of your choice is . This bank offers money market accounts as well as certificates of deposit denominated in other currencies.
There are many other ways to hedge against a falling dollar. To learn about one other strategy, check out Episode 46 about how to invest in gold.
Dollar Sign image courtesy of Shutterstock