A Political Hedge

Currency is a store of value — but one whose worth itself fluctuates over time. A hard day's work might earn you $100, but exactly what that $100 will buy varies greatly depending on the political and economic winds. Because a currency's value is dependent solely on faith in the government, the philosophy of a country's leadership directly affects its monetary exchange. As we've pointed out before, the most successful economies are always the most free.

Although the midterm elections were decidedly a referendum on President Bush's Iraq policy, they also provided further insight into the major parties' economic beliefs. Based on both their words and actions, it's painfully obvious that neither political party promotes free market capitalism as an integral component of their platform.

The Democrats, whether it be their advocacy for a minimum wage, universal health care or protectionist trade policies, are seemingly devoid of any free-market or laissez-faire bent. Even if you support those initiatives, you'd have to admit — they are far from capitalist.

Bush, to his credit, attempted to approach the third rail of politics by addressing the Social Security time bomb (an effort quickly kyboshed by members of both parties). Yet he has also increased nondefense spending at a historic rate and presided over the draconian Sarbanes-Oxley laws, which are literally draining life from the capital markets on a daily basis. From a capitalist perspective, Bush talks the talk...but has hardly walked the walk.

In the wake of the elections, many commentators are opining on how the Republican rout will affect our investments. Some sectors reacted quickly; for example, drug and pharmaceutical stocks dropped in anticipation of Democrats forcing lower prescription prices. But as Washington's new agenda takes shape, the market in which I'm expecting to see the most profound effect isn't in stocks or bonds, but currencies.

More than any other asset class, Americans own dollars. We earn and spend dollars. We hold them in our wallets, checking and savings accounts. We live, think and breathe in dollars. So regardless of who you voted for, the fact is that as a nation we're "long" U.S. dollars in a big way. And it's not just we Americans who've put the majority of our earned assets into the greenback. According to the IMF, 66.3% of all official foreign-exchange reserves are held in U.S. dollars, with 24.8% in euro, 3.4% in Japanese yen, and 4.0% in the British pound.

When confidence in a currency declines, the results can be disastrous. A recent story about the Congo's economic crisis in the Associated Press illustrates how governmental corruption and disarray can literally destroy a currency's value.

When introduced in 1998, the Congolese franc had a value of roughly five to the U.S. dollar. Since then, its value has plummeted to 460 francs to the dollar in July, and more recently, more than 540 francs to the dollar. Citizens are forced to carry bags and huge wads of virtually worthless banknotes. It's a situation reminiscent of the German hyperinflation of the early 20th century, which we wrote about in this space a few years back.

And while the U.S. dollar still remains the world's reserve currency, recent political and economic developments have prompted me to increase my allocation to foreign exchange beyond the good 'ole greenback. You can debate if higher taxes and minimum wage, along with a move toward expanding entitlements such as Social Security or universal health care are worthy goals, but one thing is certain: They aren't free. As the anticapitalist, welfare state expands, it's my belief the value of the dollar will undoubtedly decline.

To that end, I'm expanding my positions in foreign exchange, including using many of the groundbreaking currency ETFs we wrote about last summer, which mimic the daily prices of currencies. From the Swedish krona (FXS) to the Swiss franc (FXF), diversifying into a foreign currency is now just as efficient as buying shares of GE (GE). The ETFs rise as the value of the dollar declines relative to the underlying currency. They are unleveraged, pay regular interest, and, unlike futures or options, don't need to be constantly rolled over into future expiration dates. Moreover, the fact that the funds continue to trade miniscule volumes even amid strong price action is my best indicator that the real gravy has yet to be made.

With neither political party representing the interests of honest, profit-seeking capitalists, it's clear that ominous economic winds are beginning to blow. Dumping the dollar might be precisely the trade that provides shelter from the gathering storm.