November 2007

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A different look at inflation

Inflation is not just about interest rates
By Ronald W. Rogé, MS, CFP

If you haven’t vacationed abroad recently, you might be unaware of the U.S. dollar’s sharp decline against many of the world’s major currencies.

Most Americans don’t look at the value of the dollar everyday, as they do the stock and bond markets. It’s typically only when you travel to a foreign country you realize how much the greenback’s global purchasing power has shrunk lately.

Battered by a number of factors, including continuing trade deficits and turmoil in the credit markets, the dollar has dropped sharply over the past year against such currencies as the British pound, the euro, and the Canadian dollar, not to mention the Indian rupee and the Brazilian real.

More specifically, the dollar’s slump has left it at a 26-year low against the pound, a 30-year low versus the Canadian dollar, and, more significantly, at a record low against the euro.

That’s not good because a weakened dollar increases the cost of the imported goods Americans have grown addicted to, as well as exerts upward pressure on interest rates. And that’s not even factoring in inflation, which has averaged 2.75 percent annually over the past seven years.

Over that period of time (Aug. 1, 2000, to Aug. 1, 2007), the dollar declined more than 47 percent (from $0.92 to $1.36) against the euro, with nearly a quarter of that slippage occurring over the past 12 months.

So now you know why it really feels like inflation is higher than the official data would suggest.

Government actions can affect the official Consumer Price Index (CPI) numbers and, of course, the government wants Americans to feel that inflation is under control. Current administration policies have led to a sharp slide in the value of the dollar. That situation is unlikely to change any time soon due to a

When the dollar’s value falls, it is easier to repay (or at least service) the huge deficit that has accumulated in recent years. So when the dollar drops 30 percent to 40 percent, foreign creditors will be paid back in U.S. dollars that are worth commensurately less.

It’s a bit of economic slight-of-hand that benefits the country in the short run; although it carries the very real risk it will undermine the dollar’s pre-eminence in the global currency markets.

WHAT DOES THIS MEAN TO YOU?

So how should you respond to these developments? If you believe the dollar will continue to weaken, you should have significant exposure to foreign stocks, multinational U.S. stocks, natural resources, and foreign bonds.

Most Americans do not have enough exposure to foreign equities and bonds. While it’s true you can get a useful measure of foreign exposure through U.S. multinational corporations that dominate the S&P 500 stock index, consider that:

• Foreign markets matter more now, reflecting the expansion of the global economy. Whereas American equity markets represented about 70 percent of global equity capitali-zation in the 1970s and 1980s, it’s less than 50 percent now;

• Many foreign economies — China and India, for example — are growing faster than that of the U.S.; and

• According to the most recent Forbes magazine ranking of the world’s largest public companies, 16 of the top 30 were based outside the U.S.

Ronald W. Rogé, MS, CFP, is the chairperson and CEO of R. W. Rogé & Company, Inc., a wealth-management firm. He can be reached at 877-218-0085 or through the Web site, www.rwroge.com.

Disclaimer: R.W. Rogé does not intend to provide investment advice through this article and does not represent that the securities, indices, or investment strategies discussed are suitable for any investor.

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