Is a Declining U.S. Dollar Good for the Investment Climate?

GALLUP NEWS SERVICE

PRINCETON, NJ -- The U.S. dollar has fallen 6.7% against the euro and 3.3% against the yen this year and it is expected to continue its decline as 2005 gets underway. The decline of the dollar suggests the Federal Reserve will have to pursue its course of steadily increasing interest rates. But what does the declining dollar mean for the investment climate?

Even as the value of the dollar continued to plunge during the weeks before Christmas, the equity markets have done remarkably well with the Dow reaching a 3 1/2-year high and the S&P Index hitting its highest level since August 2001. Given this performance, it is not surprising that the UBS/Gallup Index of Investor Optimism, which measures personal and overall economic optimism among the nation's investors, increased for the second month in a row in December. 

Does this increase in investor optimism suggest the potential benefits of a declining dollar outweigh its potential costs in the eyes of U.S. investors? Even more importantly, does this mean that the president and Congress can continue to spend freely, run huge budget and trade deficits, and count on a (downward) floating dollar and (steadily tightening) monetary policy to compensate for these imbalances in the world markets?  

Investor Optimism Increases

The Index of Investor Optimism increased for the second month in a row in December and stands at 79 -- up 10 points from November (69) and up 17 points from 62 in October. This is the highest level of investor optimism since July (when it was 88), but still far below last December's level (104).

Almost all of the increase in optimism came in the Personal Dimension, which tracks investors' optimism about their own personal investment situations, as it increased to 62 from 53 in November. Investors are now slightly more optimistic about their ability to make their investment goals/targets and increase their incomes during the year ahead than they were last month.

In sharp contrast, the Economic Dimension, which measures optimism about the country's overall economic situation, increased only one point, from 16 to 17. Investor optimism about the prospects for the economy remains essentially unchanged in December from November. The Economic Dimension is 24 points below its level in December 2003.

Factors Hurting the Investment Climate a Lot

As has been the case for many months, investors identify job outsourcing and the price of energy as the top two factors hurting the current investment climate the most. Sixty-one percent of investors say job outsourcing is "hurting a lot" and 59% make the same assertion about the price of energy. Concern about the federal budget deficit is next with 54% saying it is hurting the investment climate a lot, followed by questionable accounting issues and the situation in Iraq at 46%. The declining value of the dollar comes next with 44% saying it is "hurting a lot," while only 33% point to the threat of more terrorist attacks and 23% to general economic conditions.   

How Do Investors View the Falling Dollar?

While it is not at the top of the list of investor concerns, three in four investors (77%) say the declining dollar is hurting the investment climate "a lot" (44%) or "a little" (33%), while only 7% say it is helping "a lot" (1%) or "a little" (6%). Evidently, most investors do not buy the argument that the potential competitive benefits for U.S. farmers, manufacturers, and other exporters associated with the declining dollar outweigh the potential costs in terms of higher import prices and higher interest rates.

On a personal level, 4 in 10 investors (39%) say that the declining value of the dollar will cause them to spend less on imported goods and overseas travel. Only 6% say they will increase their spending on imports and overseas travel, while 54% say the declining dollar will have no impact on their spending.

Priorities for the Congress and President in 2005 

What can be done to stem the decline of the dollar? One possibility would be for the president and Congress to make an aggressive effort to reduce the federal budget deficit. In fact, 84% of investors say that the top or major priority for the president and Congress should be reducing the federal budget deficit in 2005.

At the same time, however, 76% say increasing health coverage for those who are not covered should be the top/major priority and 60% say providing more federal aid for the  "No Child Left Behind" program should have such top/major priority status. Fifty-nine percent of investors point to restructuring Social Security, 50% to cutting personal income taxes, and 40% to replacing the current federal income tax system with a flat sales tax.

Although investors are strong supporters of reducing the federal budget deficit, they -- like most other Americans -- also offer strong support for major new federal spending programs and tax-cutting efforts. It is this strong support of a wide range of new spending programs and revenue-reducing efforts that makes holding the line on the federal budget deficit so difficult politically, particularly when the nation is also funding military and humanitarian efforts in Iraq and Afghanistan.   

Fixing the Imbalances

Investors have good reason to be less than enthusiastic about the economic outlook in the months ahead. There seems little prospect that anything will be done to address their top concerns, including job outsourcing and energy prices, in early 2005. Nor is there likely to be much done about the federal budget deficit given the public's strong support for federal spending and federal tax cuts. Even investors who are strong supporters of reducing the federal deficit also say a top/major priority for the federal government should be to spend more on major health and education programs.

What does this mean for the dollar? If the federal budget deficit and U.S. trade deficit continue to grow, the U.S. dollar will continue to experience downward pressure. Monetary authorities will be forced to increase interest rates, import prices will escalate, and the declining dollar is likely to soar to the top of investor concerns in early 2005.

While the equity markets seem capable of ignoring such "weakening dollar" concerns right now, it is hard to see how this can continue for too many more months. Early in 2005, we're likely to learn that the majority of investors are right: A falling dollar is not good for the investment climate or for U.S. investors and consumers.

Survey Methods

Results for the Index of Investor Optimism -- U.S. are based on telephone interviews with a randomly selected U.S. sample of 805 adult investors, aged 18 and older, with at least $10,000 of investable assets, conducted Dec. 1-14, 2004. For results based on this sample, one can say with 95% confidence that the maximum error attributable to sampling and other random effects is ±4 percentage points. In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls.