Why Is the U.S. Dollar Declining—and What Does It Mean for Investors? (EP.213)

0:28We all need to make smart decisions with our money. there is a link to subscribe to my newsletter, which comes out every other Wednesday. But on July 23rd, that newsletter will include a link to my quarterly webcast. It is a recording and you can watch at whatever speed you want. All the slides are there. All the notes are there. And today's topic is one of the pieces that I found interesting in putting that webinar together. Because as I look at 2025 thus far, a huge story has been the strong performance of non-U.S. equities with the MSCI All-Country World X-US Index generating roughly a 19 % return.

1:06But here's what the interesting part of it is, is that roughly half of that is just local stock return, and then the other half is currency gain, clearly reflecting a significant decline in the US dollar. Now, it's easy to succinctly explain why the past unfolded the way it did, but let's not lose sight of the inherent lack of predictability of policy, currencies, and asset prices. I just felt that because a massive dollar bull market has been such a big contributor to the U.S. stock market outperforming for the past 15 years or so, I think it's worth digging into the decline of the U.S. dollar just to give some additional context to non-U.S.

1:46stocks outperforming thus far in 2025. So how do currency fluctuations impact your investment returns? Imagine you're a U.S. investor and you decide to buy shares in a lemonade stand. We'll call it Golden Squeeze Lemonade using U.S. dollars. After one year, your returns depend solely on how well Golden Squeeze Lemonade performed. Now, let's say you also invest in a French lemonade company. And let's see how my French accent is. We'll call it Lemonade Fresh. To make this investment, you first convert your U.S. dollars into euros. So for simplicity, let's assume that at the time of your initial investment, one US dollar equals exactly one euro.

2:30So you'd exchange one thousand dollars into one thousand euro and invest all of it into Lemonade Fresh shares. Fast forward one year, your investment in the French lemonade company has grown 10 percent, turning your one thousand euro into eleven hundred euro. But here's the key factor. During that same year, the value of the U.S. dollar declined relative to the euro. So now instead of being equal to one, one euro is now worth$1.10. So when you're converting back your 1 ,100 euro into U.S. dollars, you're actually going to receive 1 ,210 U.S. dollars. Put more simply, because of the dollar's decline, your total return in U.S.

3:14dollars is now 21%, significantly higher than your original euro-based return of 10%. And if the opposite had occurred and the U.S. dollar had strengthened, well, let's say like the euro is then worth only 90 cents in U.S. dollars. Well, then when you're converting back your 1 ,100 euros into U.S. dollars, you would only have$990, effectively turning your original 10 % gain in euros into a small dollar loss in US dollar terms. And this is how currency fluctuations impact your investments. But I guess it's also important to understand why currencies fluctuate in the first place. So the econ 101 version is that currency values are driven by supply and demand dynamics, just like the prices of goods and services.

4:02When demand for a currency exceeds its supply, its value increases. And conversely, when supply exceeds demand, its value decreases. There are all sorts of factors that influence these supply and demand dynamics. Interest rates play a major role. Higher interest rates in a country attract foreign capital, boosting demand for that country's currency. And inflation also matters. Higher inflation typically reduces a currency's purchasing power, causing it to lose value relative to currencies with lower inflation. Additionally, there are things like economic growth rates, government debt levels, political stability, and trade balances that all eventually affect currency strength.

4:41I think with that fundamental understanding in place, we can start to understand why analysts initially misjudged the direction of the U.S. dollar in 2025. Initially, the narrative was straightforward. Tariffs imposed by President Trump's administration would lead to higher inflation, and higher inflation would prompt the Federal Reserve to raise interest rates, attracting capital flows and strengthening the dollar. But that scenario didn't unfold as expected. Instead, the dollar index, which tracks the dollar against currencies like the euro, the yen, the pound, it has dropped approximately 10 % in just six months, which for a currency, particularly the dominant global currency is a pretty significant move.

5:26And so you might ask what changed investors' minds from going into 2025 to the current moment that we're in. And I think in general, markets simply underestimated the complexity of tariffs and their broader macroeconomic impact. So rather than fueling inflation significantly, tariffs are now expected to slow economic growth and slower growth typically translates into lower interest rates. So we've seen markets pivot pretty sharply because at the start of the year, few people were expecting any kind of rate cuts, but now we can see that investors are pricing in several rate cuts by the Federal Reserve within the next 12 months.

6:04There are also growing concerns about the U.S. debt levels, with the federal deficit projected to exceed 6 % of GDP in both fiscal 2026 and fiscal 2027. Plus, the U.S. debt is projected to balloon from 97.8 % of GDP today to nearly 123 % by 2034. And yet another piece of the puzzle are the demographic trends and the policy impacting the labor supply. And now you might think that I'm oversimplifying economic growth with what I'm about to say, but I assure you that I'm not. Basically, economic growth is just a combination of the growth in labor supply and the growth in productivity. It really just comes down to those two factors, believe it or not.

6:47And so when we think about labor supply, immigration policy changes could reduce the annual net immigration below half a million, down from over a million annually in the previous decades. Plus, baby boomers continue to retire. So the working age population is expected to steadily decline, leading to persistent labor shortages and sustained inflation pressures. I think all these things, it just adds to the complexity of an already pretty murky situation. And you might ask, what does this all mean for me as an investor? What does a falling dollar mean for your investment strategy? Historically, strong capital inflows into U.S.

7:25assets have supported the dollar. However, these current conditions, this slower growth, the rising inflation concerns, the mounting federal debt could diminish the appeal of U.S. stocks and bonds. Additionally, despite tariffs, the U.S. is likely to continue running substantial trade deficits, applying further downward pressure on the currency. Meanwhile, there are valuation differences that are wide between U.S. equities and international equities. U.S. equities currently trade at almost a 50 % premium to their international counterparts based on a forward price-to-earnings basis. Plus, international stocks' dividends, they're almost double that of the U.S.

8:06equities at this point in time. And so after two decades of investors paying premium prices for American exceptionalism, investors might rightly ask themselves if this premium remains justified. Of course, as long-term investors making big short-term bets based on currency movements or any of this macroeconomic outlook talk is usually unwide. But I do think that the structural trends that I'm highlighting here really reinforce the already compelling case for non-US stocks. Because for the past decade plus, we've been talking about you have to keep your non-US stock allocation in place for diversification benefits.

8:45Now the story perhaps has another element to it. Thank you as always for listening. And if you enjoyed this episode, please consider leaving a review in your podcast app. I'd love to hear your thoughts. Again, thanks for listening. And until next time, to long-term investing. Thanks for listening to the Long-Term Investor Podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com. Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan.

9:26This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.