Taking Advantage Of A Weak U.S. Dollar

Between 2003 and 2008, the value of the U.S. dollar fell compared to most major currencies. The depreciation accelerated during 2007-2008, impacting both domestic and international investments. The impact of the rise or fall of the U.S. dollar on investments is multifaceted. Most notably, investors need to understand the effect that exchange rates can have on financial statements, how this relates to where goods are sold and produced, and the impact of raw material inflation.

The confluence of these factors can help investors determine where and how to allocate investment funds. Read on to learn how to invest when the U.S. dollar is weak.

The Home Country
In the U.S., the Financial Accounting Standards Board (FASB) is the governing body that mandates how companies account for business operations on financial statements. FASB has determined that the primary currency in which each entity conducts its business is referred to as "functional currency". However, the functional currency may differ from the reporting currency. In these cases, translation adjustments may result in gains or losses, which are generally included when calculating net income for that period.

What does all this technical-speak mean when investing in the U.S. in a falling dollar environment? If you invest in a company that does the majority of its business in the U.S. and is domiciled in the U.S., the functional and reporting currency will be the U.S. dollar. If the company has a subsidiary in Europe, its functional currency will be the euro. So, when the company translates the subsidiary's results to the reporting currency (the U.S. dollar), the dollar/euro exchange rate must be used. For example, in a falling dollar environment, one euro buys $1.54 compared to a prior rate of $1.35. Therefore, as you translate the subsidiary's results into the falling U.S. dollar environment, the company benefits from this translation gain with higher net income.

Why Geography Matters
Understanding the accounting treatment for foreign subsidiaries is the first step to determining how to take advantage of currency movements. The next step is capturing the arbitrage between where goods are sold and where goods are made. As the U.S. has moved toward becoming a service economy and away from a manufacturing economy, low-cost provider countries have captured those manufacturing dollars. U.S. companies took this to heart and started outsourcing much of their manufacturing and even some service jobs to low-cost provider countries to exploit those cheaper costs and improve margins. During times of U.S. dollar strength, low-cost provider countries produce goods cheaply; companies sell these goods at higher prices to consumers abroad to make a sufficient margin.
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