Look Out Below!

The dollar is falling! And the sky, too! At least that's what the media has likely led you to believe. The greenback has indeed fallen against major currencies so far this year, and the decline accelerated a couple of weeks ago. But that's about the extent to which the media gets it right. Their facts may be correct, but there interpretations are anything but. As such, we thought it prudent to discuss some common dollar misconceptions and hopefully leave you confident the currency's decline doesn't portend disaster.

First and foremost, the talk of dollar weakness this year is overblown. Almost all of the concern has focused on its decline versus the euro and British pound. Meanwhile, the dollar is little changed against the currencies of some of our largest trading partners such as Japan, China, Canada and Mexico—which collectively make up 50% of our total trade. Thus, the dollar isn't even down 6% on a trade-weighted basis (which weights all currencies by the amount the country trades with the US). That isn't much more than the dollar was up in 2005.

Many pundits cite the US's "twin" deficits, budget and current account, as causes for dollar decline. Yet, exchange rates are monetary phenomenon, while budget deficits are fiscal. In other words, they're not related. To wit, the US ran huge budget deficits during the 1980s and early 1990s, and there were periods when the dollar rose dramatically. The same is true for the current account. The US has run a current account deficit for the past 25 years, but we've had many periods of dollar strength and weakness since then. In addition, Australia and the UK have had strong currencies in recent years, yet both countries run large current account deficits. You can't argue these deficits are bad in the US but not elsewhere.

Perhaps the most feared misconception is a weak dollar is bad for the stock market. This is simply not true. Currencies don't dictate the direction of the stock market, or vice versa. They're driven by their own supply and demand dynamics. But even if they weren't, the US makes up about 50% of the global equity market. If the falling dollar was bad for US stocks, shouldn't it be good for the 50% worth of non-US stocks?

Weak or strong, don't fret currencies. Like stocks, currencies can swing sharply in one direction or the other in the short term. But over the long run, the currency effect is minimal in a well diversified portfolio.