A weaker dollar may offer opportunities, but use care

— -- You've probably heard that the U.S. dollar is in trouble. For example, historians have challenged some of the anecdotes in its autobiography, A Trillion Little Greenbacks— particularly the episode involving Alexander Hamilton, George Washington and 12 quarts of caramel sauce.

But there's no doubt that the dollar has fallen steeply against other currencies recently. The St. Louis Federal Reserve bank's trade-weighted dollar index has fallen 12% since March, and 20% since 2002. The index measures the value of the dollar vs. the USA's major trading partners.

You may be able to make some money from the dropping dollar, but be careful making a long-term bet against the buck.

Why the dollar has fallen:

•Low interest rates. Money tends to flow to the currencies that offer higher yields, all other things being equal, driving up the value of those currencies. A three-month U.S. Treasury bill yields 0.09%, while a three-month German government bond yields 0.36%, and a three-month Japanese government bond yields 0.17%.

•Lessening fear. Investors flee to the safety of U.S. Treasuries when they're terrified. Investors were petrified in March and drove up the value of the dollar. Now that some worries about the world economy have moderated, the dollar has begun to slip.

•Increased borrowing. The U.S. debt load — currently $11.8 trillion — has started to worry investors.

Yet despite the debt, some economists think the dollar could be close to a near-term bottom. "U.S. economic fundamentals have been fairly positive," says Ron Simpson, managing director of global currency analysis for Action Economics.

A lower dollar will "put more juice behind exports," says Brian Bethune, director of financial economics for IHS Global Insight. "Big exporters like GE and Intel and John Deere — you're not going to hear them complaining about a lower dollar."

A $20,000 tractor made in the U.S.A. would have cost 14,187 euros at the end of 2008; it would cost 13,617 euros now.

As U.S. growth increases and the recovery takes hold, the Federal Reserve will begin to raise interest rates. IHS Global Insight thinks the Fed might start to nudge its key fed funds rate higher by next summer; Action Economics thinks it might start as early as the first quarter of 2010. Higher rates, in turn, should push the dollar up.

In the long term, however, the nation's huge and growing debt will be a drag on the dollar. "It's clearly not sustainable," Simpson says. "It won't be that long before investors start questioning the value of the dollar."

A dollar collapse is unlikely. For one thing, what other currencies will investors flee to? U.S. government debt is currently equal to 61.5% of gross domestic product. But Germany's debt is 76.4% of its GDP, Italy's is 104.3%, and Japan's is nearly 200%, according to the International Monetary Fund.

Still, if you think the dollar is in for a tumble, you have several ways to play it:

•Gold. At $1,012 an ounce, gold isn't cheap. But the yellow metal typically rises when the dollar falls, and vice versa. If you don't want to own the actual metal, consider iShares Comex Gold Trust (ticker: IAU), an exchange traded fund that invests in gold bullion.

•Currency funds. If the dollar falls in value, you'll make money. For example, suppose you had bought 20,000 euros at the end of 2008 for $1.4097 apiece, or $28,194. If you cashed them in today, at $1.4749, you'd have $29,498.

Stick with major currencies, unless you have inside insight into the Swedish krona. One suggestion: CurrencyShares Euro Trust (FXE).

If you're considering an actively managed fund, international income funds are a decent bet. These invest in foreign bonds. Should the dollar continue to decline, these bonds should increase in value. And even if the dollar does reform itself, international bonds are a decent way to diversify your portfolio, if used in moderation.

John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. new book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com. Twitter: www.twitter.com/johnwaggoner.