StreetTalk: Weak Dollar Could Give Foreign Biopharms a Boost — but Hold US Firms in Check

I've heard that economics forecasting is an occupation that gives astrology respectability. But even economists are right to lament the direction of the US dollar. Although it has stabilized of late, the dollar's performance over the past few years has been sorry, indeed. The ramifications of said performance could be huge for American industry - including the biopharm market, which must fend off more overseas competitors than most industries.

Brian O'Connell

Yes, I know. The US dollar is the most widely held financial asset in the world. But it is also the most dangerously overvalued asset in the world — and one of the worst performing.

We've seen the bottom dropping out of the US currency for more than a year now. In late 2004, the dollar hit an all-time low against the euro. It dropped 36 percent from its high four years ago and is down a whopping 93 percent in the last 61 years. As a result, the US current account deficit — the broadest measure of foreign trade — has risen to nearly $600 billion, or around six percent of gross domestic product, as Americans buy more from overseas than US businesses can export. Questionable decisions on interest rates from the Federal Reserve, record high oil prices, and the uncertainty over the war in Iraq has sent the dollar on a downward spiral.

FOREIGN INTERVENTION KEEPING DOLLAR AFLOAT

Worse, the US dollar is no longer backed by gold or silver or anything else for that matter. The only thing backing it today is the "full faith and credit" of the US government.

The trouble is that the US government now has over $7.4 trillion in outstanding debt ... trillions more in "off-balance sheet" obligations (like Social Security and Medicare) ... and it's adding to its unproductive debt at the rate of more than $1 billion a day.

At the same time, foreign central banks and investors have kept the dollar afloat over the last few years. Foreign governments like China and South Korea have purchased nearly a quarter of our national debt. But our latest indicators show that overseas investors are beginning to offload US government bonds.

As foreigners see a US twin deficit (fiscal and trade) climbing over the $1 trillion mark a year, and national debt on track to hit $10 trillion in the next two years, their appetite for dollars (and dollar debt) seems to be abating. And this is placing a groaning burden on the dollar.

The next major down leg of the dollar, in fact, has already begun. In the last three years, dating back from December 30, 2004, it's down 32 percent against the euro, 25 percent against the pound, 33 percent against the Swiss franc, and 23 percent, 34 percent, and 44 percent against the Canadian, Australian, and New Zealand dollars.

But if you still think this is only a concern for currency traders and tour operators, think again:

• Dollar devaluation in the 1930s coincided with the biggest bear market in history.

• After the US went off the gold standard in the '70s, a 10-year bear market followed.

• The Crash of '87 was preceded by a 35 percent devaluation of the dollar against major currencies in the previous 18 months.

• The current fall of the dollar has already coincided with the biggest US stock market crash since 1929.

WHY WORRY?

In short, a sustained decline of the US dollar could affect the value of US stocks, bonds, and real estate in a dramatic way. Even in the biopharm market, a weak US dollar could pave the way for higher interest rates (we're already seeing some of that), more expensive research and production borrowing costs, and a real disadvantage for US companies battling their overseas counterparts in this new global economy everyone is talking about.

But it's the stock market that worries me the most. The US stock market, that is.

As US investors notice the dollar drain, they unflinchingly reach for the phone to call their broker or financial advisor and demand that their portfolio's exposure to international stocks be increased. Consequently, sell-offs of US stocks can decimate the US stock market and lead to a down year for big industries like biotech and pharmaceuticals. You see this trend quite often in the mutual fund market, where fund outflows — money being sucked out of funds by anxious investors — rise during periods of a declining dollar and fund inflows for international mutual funds during the same period rise.

And it's easier to invest overseas than ever before. In this day and age, modern technology and some creative minds on Wall Street have given investors user-friendly but sophisticated tools like international-exchange traded funds. This allows investors to buy into a group of large, overseas companies that are primed to take advantage of the weak US dollar for a fraction of the cost of investing in such companies separately. Think "index funds on steroids" and you begin to get the picture on foreign exchange traded mutual funds. Altogether there are about 21 non-US country specific index exchange-traded funds, trading in bourses like China, Switzerland, and New Zealand, areas considered safe havens by investors wary of a declining dollar. There are also a handful of region-specific funds for investors to mull over.

Unfortunately, our bad news is somebody else's good news. For overseas biopharm firms, a weak dollar may give them more incentive to invest more in relatively cheaper resources in North America. In the auto industry, Volvo is already making noises about moving one of its plants from Sweden to the US (most likely to Asheville, NC), to take advantage of a declining dollar. There is little reason why biopharm firms shouldn't or couldn't follow suit.

A SILVER LINING

Just because the indicators say that the dollar's decline is a negative one doesn't necessarily mean it will come to pass.

Respected investment minds like John Dessauer, who correctly augered Germany's dollar slide in 1984 and made millions from it, maintains that even with the dollar falling below 100 yen and reaching highs of $1.35 against the euro, the US economy should be okay. He says, again correctly, that many foreign investors are still pouring their portfolio dollars into US markets. He also points out that, historically, when US economists see the national deficit soaring, they also see capital account surpluses growing in parallel.

Federal Reserve Chairman Alan Greenspan also has commented that the American economy is well equipped to withstand further erosion of the dollar, which seems to have calmed down a lot of people, especially foreign investors who want to invest in the US. All they need is a good reason to invest, and pro-US economy utterances by Mr. Greenspan seem to suffice.

Plus, the situation in Europe is not as rosy as the global financial media might have you believe. Currency appreciation and lackluster domestic demand for euroland goods and services have held economies across the big pond in check. The US dollar also has hurt euro (and Japanese) exports.

So the situation in the US over the sluggish dollar may not be as bad as you or I may think. From a business standpoint, a tepid currency picture may cause biopharm companies to put the breaks on initiatives in places like information systems, research and development, and even hiring. And that may transpire in 2005. More likely, the dollar will somehow stay afloat throughout the year and pacify nervous investors looking for an exit strategy.

Confused? Me, too. Like I said, it's economics. President Harry Truman once famously said that he was looking high and low for a one-armed economist — one who could never say, "on the one hand this and on the other hand that."

But the takeaway here is to recognize that although the dollar's troubles are real, the resiliency of the US economy and the strength of our reputation, financially anyway, should carry us through this currency crisis.

If not, I know where you can get a good deal for a drug company on the cheap.

Celebrity author and business/finance commentator for CNN and Fox News, Brian O'Connell has written for The Wall Street Journal and Newsweek, 79 Radcliffe Drive, Doylestown, PA 18901, 267.880.3144, fax 267.880.1939, brian.oco@verizon.net