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The Fading Greenback

The U.S. dollar isn’t as popular as it once was.

In the second quarter of this year, which ended on June 30, the dollar’s share of global currency reserves fell to its lowest level in a decade, and its value dropped 6.2% as measured by the Dollar Index, which measures the U.S. currency against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona.

The president of the World Bank, Robert Zoellick, warned that the United States should not take for granted the dollar’s role as the world’s main reserve currency. The “next upheaval” in the international economic order is on its way, he said.

I agree, though I do not see an economic Armageddon around the corner. It will take some time to develop. And, when the day of reckoning comes, well-prepared investors should be able to get through the upheaval with less damage than others who assume that the United States and its currency will always remain the center of the financial universe.

For years, America has been unwilling to pay for what it consumes. In July, the country had a trade deficit of $32 billion. The federal government owes $7.2 trillion, with a budget deficit that ensures that that number will continue to soar. Eventually foreigners will lose faith in all this paper we are sending in exchange for their goods, and the value of the dollar will sink.

When that happens, Americans will find that our paychecks buy less of the foreign goods we have learned to love. Interest rates will increase as foreigners start putting their money elsewhere, making cash harder to come by in this country. The higher interest rates will make it more difficult for businesses to expand, and unemployment will rise.

None of this will be pleasant in the short run, but it will force Americans to start saving more and buying less, which will eventually bring our trade relationships back into balance. But, first, we may experience a period of high inflation, high unemployment and major government budget cuts at all levels. It has happened before, many times, when other countries have experienced currency crises. It is dangerous to assume that it cannot happen here.

Many people mistakenly think that keeping money stowed away in a mattress (or the bank account equivalent) is completely without risk. However, even cash is an investment of sorts. If all your money is in dollars and inflation takes off, those government-guaranteed bank accounts will not be worth as much as their owners expected. So even the most risk-averse long-term investors are better off holding a diversified portfolio than simply squirreling away greenbacks.

A significant part of the investments we manage are in non-U.S. assets. This guards our clients against U.S.-centered problems, like a possible dollar crash. While the collapse of the dollar would have global reverberations, the damage would be most intense in this country. We also direct a considerable share of client holdings into U.S.-based multinationals that earn significant money abroad, which helps cushion those investments from U.S. problems, as well.

Additionally, we invest in hard assets, like real estate, natural resources and other commodities. These investments tend to hold their value through periods of high inflation, making them a good hedge against a declining dollar.

Until something changes the American culture of buy now, pay later, we all need to be concerned. But a diminished dollar is just one risk among many in the investment universe. Investing is the art of balancing risk against expected rewards. The message here: Prepare, but don’t panic.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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