Foreign Currency Investing: Is the Almighty Dollar Going Down? (UUP, UDN, FXA, FXF)

Since WWII, the U.S. dollar has been the world’s reserve currency. However, since the economic collapse of 2008, the greenback seems to be getting less and less respect. In fact, just as the U.S. Federal Reserve and the European Central Bank (ECB) decide on how to move their currencies forward in the coming weeks, other central banks around the world have quietly hedged themselves against the dollar and the euro, and have started loading up on another currency altogether.

I’m talking about the Chinese yuan. And what’s going on today hopefully will be a wake-up call for America.

A Growing Global Trend

Just look at what’s happened in the last few months…

On June 22, Forbes reported Brazil and China signed a currency exchange pact that’s part of a larger move with other BRIC nations, Russia and India, and even South Africa.

They have agreed that if there’s another financial meltdown and global credit dries up, each country’s central bank will have money set aside to help the other and keep their economies running smoothly.

Now let’s go back to March. Australia signed a $31-billion currency exchange deal directly with China to promote trade and investment between the two nations.

In December 2011, Japan announced a currency pact with China that topped headlines. Japan and China are the third and second largest economies in the world.

Also in December was another agreement with Thailand.

Every one of these deals limits the power of the U.S. dollar a little bit more in these countries and gives more value to the yuan.

However, all this being said, the yuan isn’t ready for the world stage, either.

Still Problems in China

Despite the yuan’s growing acceptance around the globe, its value is still managed by the state. In fact, while China will be the first to deny it, it has kept its currency artificially low for years.

What’s more, the yuan isn’t convertible or allowed to trade freely outside the country yet.

And on top of all of this, China really doesn’t want its currency appreciating right now. Over the past five years, the yuan has climbed 18% against the U.S. dollar.

That has made profit margins tight in China. With its economy continuing to slow down in recent months, Chinese exporters could get crushed if the yuan is left to trade freely in the markets.

Point is, the future of the yuan is as much about how China’s government manages its currency problems as it is how the United States and Europe get their deficits in order.

Moving Forward

Unfortunately, there’s no predicting the future. But one thing is certain: China knows it has to change the way it controls the yuan.

The People’s Bank of China, the central bank, proposed a series of currency reforms earlier this year that suggested internationalizing the yuan in stages.

As Time magazine reports, the plan would allow the markets to freely trade the yuan in the next three to five years. In the long term, between five and 10 years, foreign investors would be given more access to Chinese stocks, bonds and property.

China has repeatedly expressed how the U.S. dollar should no longer be considered the world’s reserve currency. But at the same time, it can’t exactly afford to see the dollar go bust against the yuan.

So how could anyone play this trend?

Our very own Senior Analyst Carl Delfeld recently suggested diversifying your global portfolio into other currencies altogether such as the Swiss franc, through the CurrencyShares Swiss Franc Trust (NYSEARCA:FXF), or the Australian dollar, through the CurrencyShares Australian Dollar Trust (NYSEARCA:FXA). And Jason Jenkins recently wrote about the relative strength of the Swedish krona, here.

However, as Carl warned, just don’t go overboard. You could be crushed by a snapback in the U.S. dollar.

Good Investing,

by Mike Kapsch, Investment U Research


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