The Decline of the Dollar

The United States dollar has served as the world's main reserve currency since it took over from the British pound after World War II. Asian countries in particular hold huge amounts of US treasury debt as backing for their own currency. The Bush administration has cut taxes and increased spending, especially spending on war in the Middle East. As the national debt rises higher and higher, how will it be paid off? The choices are raising taxes, cutting spending or allowing inflation to do the dirty work. The President is famously in favor of tax cuts, and has said that the war in Iraq will continue through the end of his term. If a Republican wins in 2008, he or she is unlikely to end the war quickly, and the leading democrat, Hillary Clinton, voted for the war. So the huge deficit continues into the indefinite future. Those countries that hold all these dollar reserves must be thinking that a little diversification would be prudent, most likely into the euro and the yen, I would think, though Far Eastern politics might make yen reserves unlikely. Such a change, plus the increased amount of debt to finance, would force the US to raise interest rates to attract sufficient funds. And these higher interest rates would be bad for US stocks. So I'm thinking it's time to devote a significant fraction of the portfolio to European stocks and perhaps Japanese ones as well. Even if the stocks go nowhere in their native currency, the currency shifts will turn them into big dollar gainers, and the US stocks by comparison will suffer from the effects of high interest rates.

One mutual fund that looks attractive is Vanguard's Developed Markets Index Fund (VDMIX). It's invested 2/3 in Europe and 1/3 in the Far East. Today's price is $11.38.