Two weeks ago, at a financial conference, a member of the audience asked an all too familiar question, “What’s your view on the U.S. dollar?”

Long-time readers know I never shy away from this topic.

In fact, last year, when everyone else believed the world’s reserve currency was about to be usurped by the euro, I predicted it would rally and we would see the end of the weak dollar. And rally it did. After the impressive move, of course, I changed my stance on the falling dollar.

And since that time I’ve only become more convinced the U.S. dollar is doomed to lose value over the long term. Here’s why we need a weak dollar…

Why We Need A Weak Dollar: A Dramatic Shift in Power

One of the first reasons why we need a weak dollar is that we are witnessing a dramatic shift in the balance of power. For decades, the U.S. dollar garnered strength from our big spending ways. After all, we were the world’s largest economy and the buyers of last resort. But now we’re getting serious competition from emerging economies.

“The emerging world is not just a source of supply [anymore] but also a source of demand,” says Robert Sinche, head of strategy for currencies, global rates and commodities for Bank of America.

For instance, Brazil, Russia, India and China alone now account for 15% of global GDP, up from 8.7% in 2004.

As time elapses, the relative size of the U.S. economy will only continue shrinking, bringing its significance and, ultimately, the value of the U.S. dollar down with it.

Second, U.S. policymakers want and actually NEED a weak dollar. It’s the only way to make our goods cheaper to foreign buyers and in turn, start shrinking our massive, and record, current account deficit.

As it stands now, the U.S. budget deficit to GDP ratio rests at 13.1% – one of the highest among G-10 nations and up from 3.2% in 2008. In 2010, it will stay in double-digit territory, around 10% – this all but ensures we’ll keep issuing new Treasury securities, which every investor knows weakens a currency.

The last reason the dollar will falter is because we don’t have any control over it. Our fate lies in foreigner’s hands. With countries like China and Russia particularly, buying so much U.S. debt they can easily influence the value of the dollar.

And it won’t take drastic measures like selling their current holdings or refusing to buy any more Treasuries. All they have to do is stop buying so much of our debt, which recent statements from foreign governments suggests is becoming a strong possibility.

Three Ways to Insulate Your Portfolio From a Dollar Decline

If a long-term dollar decline is imminent, how do we protect our portfolios? One obvious way is to buy an ETF that gives us short exposure. However, I don’t think that’s adequate. We need a more comprehensive approach. I would recommend tactically adjusting your asset allocation to make sure it includes the following:

• Commodities. Real assets will appreciate in value as the dollar weakens. Look no further than the recent rise in oil for proof.

• International companies doing a majority of business outside the United States. Such companies provide a hedge against a weakening dollar, as well as a way to capitalize on the growing significance of international consumers. In other words, they offer us two ways to profit.

• U.S. companies doing significant amounts of business overseas. By focusing on U.S. companies with at least 25% of business overseas, we can diminish the impact of a weak dollar. As the U.S. dollar falls in value these foreign profits will become more valuable.

In the end, I’m not about to join the camp of pundits proclaiming the U.S. dollar will lose its status as the world’s reserve currency. That’s not going to happen, just like a prisoner with a life sentence is never going to get out of jail. There are just no alternatives.

That being said, I am convinced the dollar will struggle mightily in the years ahead while we try to rid ourselves of a crushing deficit and emerging economies become even bigger consumers. So make sure you invest accordingly.

Louis Basenese
Investment U