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The Short Answer

Should You Bet Against The Dollar?

Currency funds have recently soared, but they're still not a good idea.

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Although the subprime mortgage crisis got most of the headlines in 2007, another significant financial story was the continuing weakness of the U.S. dollar versus other major currencies. The value of the dollar versus the euro dropped 10% in 2007, following another 10% drop the year before, and is down more than 40% from its high in October 2000. The dollar also dropped 6% versus the Japanese yen last year, and it recently hit a 25-year low against the British pound, though it has rallied a bit since then.

The causes behind the weak dollar are many and complex, but essentially this means that investors around the world have become less confident in the future stability of the dollar, and more confident in other currencies, particularly the euro. The effects of the weakening dollar can also be complicated, but the upshot is that it's cheaper for people in other countries to buy American-made goods and services, and more expensive for Americans to buy things sold in other currencies. Stories of foreign tourists loading up on luxury goods in U.S. cities have become common, whereas American tourists in Europe have has their wallets squeezed--as I know all too well from my frequent trips to London.

The Explosion of Currency Funds
Another effect has been the creation of a slew of new mutual funds and exchange-traded funds that allow people to bet on the rise or fall of various currencies, especially the dollar. Just three years ago, there was only one such fund, Franklin Templeton Hard Currency (ICPHX). It invests in money market bonds denominated in various foreign currencies that the managers believe are undervalued relative to the dollar, so that it benefits when those currencies rise and the dollar falls. Since the beginning of 2005, several more such funds have sprung up. There's ProFunds Rising U.S. Dollar (RDPIX), which tracks the New York Board of Trade's U.S. Dollar Index (USDX), and ProFunds Falling U.S. Dollar (FDPIX), which shorts the same index and thus benefits when the dollar falls. There are also leveraged dollar funds that provide twice the returns (or more) of the USDX or its inverse--Rydex StrengtheningDollar 2x Strategy (RYSDX), Rydex WeakeningDollar 2x Strategy (RYWDX), and Direxion Dollar Bear 2.5x Fund (DXDDX).

David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.