The U.S. Dollar has followed a downward trend against the major currencies (e.g. Yen, Euro) for the better part of three years yet only now has the popular press caught on. The situation only stands to get worse due to pressures from Social Security, the budget deficit and trade policy to name a few. Let’s briefly take a look at each…

SOCIAL SECURITY
The current system is set up as a “pay as you go” program – today’s workers pay the benefits of today’s retirees. President Bush wants to partially privatize the program by allowing employees to funnel a portion of their payroll taxes into private accounts. Doing so would cause a funding gap necessitating borrowing by Uncle Sam to make up for the shortfall which, in turn, would put pressure on…

THE BUDGET DEFICIT
Foreign governments send money to the U.S. to fund our feeding frenzy. China and Japan alone lend us $1.8 billion per day – PER DAY! Borrowing to plug the gap created by privatizing Social Security will only exacerbate the problem. Let’s not forget about the AMT fix (estimated cost: $600 billion over ten years) and making permanent the income, capital gain, dividend and estate tax cuts (estimated cost: $2 trillion over ten years). Add in the current $2.7 trillion projected deficit and it comes to $7.7 trillion of red ink over ten years.

TRADE POLICY
Several quotas and tariffs expire on 12/31/04. Look for a flood of Chinese textiles to make their way onto U.S. shores beginning in 2005. Goods to the U.S. means Dollars go overseas to pay for the purchases.

WHAT DOES THIS MEAN FOR THE DOLLAR?
To shrink the budget gap, the federal government must raise revenue (not likely), cut costs (good luck!) or sit back and watch as the U.S. Dollar continues its decline. Even intervention by our major trading partners or a widening of the trading range for the Chinese Yuan won’t be able to stem the tide. Prepare yourself for the continuing barrage of stories from the press as it looks like a continued devaluation for the U.S. currency.

WHAT’S AN INVESTOR TO DO?
The way to benefit from a falling Dollar is to have exposure to the currencies that are appreciating relative to it. Buying foreign currencies can be tricky and expensive – particularly if one must buy many in order to properly diversify. Foreign stock funds are a poor choice as most hedge their currency risk…and let’s not forget about the equity risk associated with owning stocks. We recommend that investors purchase foreign government bonds. Buying bonds from “creditworthy countries” such as those in Western Europe minimizes default risk. Buying a foreign bond fund allows investors to diversify their holdings across many countries while gaining exposure to this sector with a small initial investment. What’s more, several of the top mutual fund companies offer high-quality, low-cost funds that do not hedge their currency risk. Investors gain not only from the coupon payments but from the “additional Dollars” purchased when the foreign currencies are repatriated. Keep in mind that this is but one strategy available to investors. Many strategies exist – each with its own risk/return tradeoff. In addition, positioning a portfolio to benefit from a single trend is no substitute for proper portfolio construction and asset allocation. We’ll try to write to you again before year’s end. If not, we’d like to use this opportunity to wish everyone a safe and happy holiday season.