Is the Almighty Dollar Dead?

It's an axiom of economics that debtors love inflation. The flip side, or course, is that creditors despise it. Why lend money today only to get paid back in devalued bucks tomorrow? That spells trouble for the almighty dollar -- and puts pressure on investors to hedge against its almost certain further decline, market professionals say.

True, the dollar is by no means dead -- but it's certainly wounded and the prognosis for the next few years looks likely to keep the world's reserve currency in the intensive care ward. It's not hard to see why. As the U.S. government goes hat in hand borrowing money to fuel unprecedented deficits, the rest of the world (our creditors) is understandably concerned.

After all, more than 50% of the world's debt is denominated in dollars. As the greenback falls, those creditors, most notably China, get paid back with something much less than they bargained for. Indeed, the U.S. Dollar Future Index, a measure of the greenback against a basket of major currencies, has crumbled nearly 11%, to less than 80, from a 52-week high of more than 89 in early March. That might not sound like much, but it has some pros feeling certain that a full-blown currency crisis is only a matter of time.

Keith McCullough, chief executive of ResearchEdge, a New Haven, Conn., research firm, says a currency crisis is all but inevitable. "The first 10% of the correction is fine," McCullough says, "but once you get below the 81 line on the U.S. Dollar Index, I call that crashing the buck."

In the shorter term that's worked out well for equity investors -- the weaker dollar is reflating their 401(k)s, McCullough says. After all, paltry interest rates and a weak dollar make equities more attractive than cash or overpriced bonds in such a scenario. A weak dollar also boosts exports and corporate revenue generated overseas. But eventually the dollar's decline will come back to eviscerate folks' portfolios. "People don't understand the correlation between the bond market, the currency market and the equity market," he says. "You have the stunning confluence of a crashing Treasury market and a crashing currency market. This hasn't happened before. The stock market is the one market that hasn't been affected yet, but it's just a question of when."

McCullough sees equities taking their hit in three to six months. As such, he's long the traditional inflation hedge of gold, as well as anything that's denominated in dollars, namely oil. (Recall that as the dollar falls, prices of goods denominated in dollars go up.) If "cash is trash," investors should look to exchange-traded funds such as SPDR Gold (GLD) and SPDR Energy (XLE), McCullough says. He's also bullish on TIPS, or Treasury Inflation Protected Securities, through the iShares TIPS (TIP) ETF. (See our recent story on investing in TIPS.)

Giles Conway-Gordon, managing partner and co-chief investment officer at Cogo Wolf Asset Management in San Francisco, paints an even more dire picture of the dollar's future. The greenback is not only suffering because of the U.S. economy's parlous state; it's being undone by a historic change in global economic leadership. "The U.S., Japan and Europe have become secularly uncompetitive," Conway-Gordon says. "The global economy is undergoing one of the shifts that happens every hundred years or so. Fundamental economic growth is moving from the G3 to the developing world, and it's not going to come back."

Like McCullough, Conway-Gordon recommends putting money to work in anything denominated in dollars (commodities), but also urges investors to disregard the U.S. market. "As a generalization we see the U.S. market as being very overbought," he says, "so invest in emerging markets where growth is quite rigorous and is going to stay that way." Conway-Gordon says investors would do well to allocate to China, India and Brazil ETFs like iShares FTSE/Xinhua China 25 (FXI), iShares MSCI Brazil (EWZ) and PowerShares India (PIN).

Douglas De Groote, managing director of United Wealth Management in Westlake Village, Calif., adds another interesting ETF strategy for playing the dollar's demise. "It makes a ton of sense utilizing the currencies and sovereign debt of other countries, as long as they are high quality," De Groote says.

Rather than just invest in hard assets denominated in dollars, buy global currencies backed by those commodities, says De Groote. "Australia makes a lot of sense and Canada makes a lot of sense," he says. Rydex CurrencyShares Australian Dollar Trust (FXA) offers cheap, liquid exposure to the currency of the land down under, while Rydex CurrencyShares Canadian Dollar Trust (FXC) does the same for America's neighbor to the north.

Finally, just because equity markets could get slammed by a weaker dollar a few months out, there are still stocks that should benefit from a declining greenback over the next three to five years, says Chris Armbruster, senior research analyst for Al Frank Asset Management in Laguna Beach, Calif. Indeed, any company with a substantial portion of revenue coming from overseas will get a sales and earnings boost from currency exchange.

"Tech is a great place to be for international revenue," Armbruster says, pointing to Intel (INTC), Microsoft (MSFT) and Hewlett-Packard (HPQ). Health care -- namely Abbott Laboratories (ABT) and Baxter International (BAX) -- is also compelling. Somewhat less obvious is Black & Decker (BDK), Armbruster says. It's attractively valued and derives 45% of its sales from international markets.