Seven Stocks That Benefit From a Falling Dollar

I'm buying one, BorgWarner. But once you understand how a weak dollar can lead to extra profits for companies in this sector -- and for the investors that hold their shares -- you can use the same logic to find other sectors offering the same kinds of opportunity.

The Dollar's Decline May Not Be That Bad

To find a falling dollar profit play, you have to start with the details of the dollar's decline.

Yes, the dollar is down big against the euro and the yen, but if you compare the dollar against what is called a trade-weighted basket of currencies, the picture looks very, very different.

According to the Fed, the dollar has declined just 12% since early 2002 against a basket of the currencies of our important trading partners. (Each currency in the basket is weighted by the amount of trade that country conducts with the U.S.) By that yardstick, the Fed says the dollar is still about 7% above its average value in the 1990s and about 17% above the trade-weighted low it hit in the second quarter of 1995.

Why the huge difference? Two reasons:

China. That country, which has become a huge U.S. trading partner, pegs its currency, the yuan, to the value of the dollar. China ran a $120 billion trade surplus with the U.S. in the most recently reported 12-month period, and during that period, the value of the yuan remained steady against the dollar. Other Asian export economies also peg their currencies to the dollar.

Europe.The European Central Bank has kept its focus on fighting inflation instead of cutting interest rates to boost economic growth, as the Fed has done. At its meeting on Jan. 8, the bank left its short-term interest rate at 2%. That left interest rates twice as high as the Fed's current 1% target. That differential has helped fuel the euro's climb against the dollar: An investor in euro-denominated assets gets an appreciating currency and more interest.

Who Gets Squeezed

These details of the dollar's decline show exactly who is getting squeezed most painfully. The Europeans face seeing their exports drop as they become more expensive to U.S. consumers. They face increasing cost competition from China as Chinese exports become cheaper with every drop in the value of the U.S. dollar, thanks to the yuan/dollar peg. European exporters even suffer a disadvantage against Japanese competitors, since that country spent more than $200 billion in 2003 buying dollars with yen to slow the appreciation of the Japanese currency. And many Europeans think the problem will get worse before it gets better. With the European Central Bank focused on inflation and the huge budget deficits in France, Germany and Italy, the betting is that European interest rates will rise in 2004. Perhaps, as Goldman Sachs has argued in the case of the bank's key short-term interest rate, to as much as 2.75% from 2% now. That likely would push the value of the euro even higher against the dollar.