What the government says

U.S. Government officials and stock market pundits like to claim that the dollar dropping in value does not matter. Of course, a certain agenda impresses a certain view point. If your job or re-election depends on the people feeling good about the economy or the markets, you will want to pretend that exchange rates do not matter. But do they or don’t they? Well, it’s all relative, as Einstein would say, for it depends on where and for what you spend your money.

The Asian connection

One reason U.S. consumers do not feel the dollar’s drop as much stems from the managed Asian currencies. The governments and central banks of various Asian countries, such as Japan, China, or Thailand, manage their currencies to stay within a certain range to the dollar. They feel that their exports to the USA would suffer otherwise, and take down their economies. Whether that is true or not is another matter. Nevertheless, by depreciating their currencies with the dollar, prices for their goods stay essentially the same for the U.S. buyers. That mutes the impact of the dollars drop tremendously, since many consumer items in stores come from these countries. Similarly, investments in those countries do not suffer greatly from exchange rate fluctuations. That may change, though, as these countries are under pressure to let their currencies rise against the dollar. Pressure from inflation.

Depreciation = Inflation

For some currencies have risen tremendously against the dollar. That has consequences for people using those currencies. A number of key commodities such as oil and gold are traded in dollars. The price for oil in dollars has more than tripled in five years. To Americans that meant massive price inflation for energy. For instance, on average gasoline prices went up more than 100% (less than oil, since costs of refining, marketing, and taxes did not rise as much). For consumers in the European countries that pay in Euros gasoline went up less than 50%. Obviously, Americans felt much more price inflation for energy than the Europeans. That also applies to German machine tools or French wine. For such products currency depreciation translates directly into price inflation. The Asian countries that peg their currencies to the dollar suffer the same problem, and they can only take so much of it. China, for instance, has started to shift its policy and will allow its currency to appreciate faster against the dollar.

Watch where you invest

Exchange rates impact more than consumer prices, though. Prices for investments suffer the same fate. In Los Angeles prices for real estate doubled and tripled. But investors that bought with Euros in 2002 saw almost nothing of that gain, since each dollar from a sale now buys close to half as many Euros. And that great recovery in the U.S. stock markets? A German that bought the S&P 500 in 2000 is still in the red in 2008, since the new record high last year did not compensate for the dollar’s decline. When a currency gains or loses 10-20% a year, it impacts investments and investment decisions. Chinese investors have to now think hard whether they want to continue buying in the USA. Conversely, Americans may benefit from investing in Asian stocks and property, as they would get more dollars back in the end. The Europeans have the tougher choice. Since many of their currencies are considered overvalued against the dollar and many pundits expect a drop, they may want to invest more in the USA to benefit from the rise. But what if the weakness continues, like other experts think? Clearly, knowing the exchange rate movements can make a big difference to your wallet.