NEW YORK (CNN/MONEY) -
Federal Reserve chairman Alan Greenspan sent the stock market into a tailspin on Friday when he warned of the dangers of a weak dollar in a speech at the European Banking Congress in Frankfurt.
The U.S. dollar has fallen 15 percent against a basket of currencies since the beginning of 2002. Moreover, while the dollar and the euro traded at par two years ago, the dollar has since dropped to a 23 percent discount.
That's bad news for Americans who plan to travel to Europe, or who have a taste for real cashmere sweaters, imported French cheese and Italian shoes.
More seriously, investors have increasingly been worrying about a dollar crash that would fan the flames of inflation, boost interest rates and possibly trigger an economic recession.
The underlying problem is that the U.S. is running a large federal budget deficit -- more than $400 billion a year -- which is causing global imbalances in trade and investing. By some calculations, the United States is gobbling up more than three-quarters of the world's surplus savings.
There is, however, one important factor that today's dollar anxiety is ignoring: In the short run, a falling dollar is good for the U.S. economy. Or to be more precise, while a continuously falling dollar is bad, a low dollar is good -- for the moment.
A little weakness helps
When the dollar keeps falling, foreign investors require higher interest rates before they'll buy U.S. bonds (or otherwise finance a deficit) because they risk losses from exchange rates.
A low but stable dollar, by contrast, encourages a little domestic inflation -- which actually would be beneficial at the moment, at least for companies that would be able to pass it on to consumers in the form of price increases.
A low dollar also boosts profits for U.S. exporters and for multinational companies that generate a significant percentage of their earnings in foreign markets.
In short, a falling dollar can be stimulative, as long as it doesn't go too far. So far, we're within the safety zone, a fact that Greenspan acknowledged in his speech by noting that over time market forces would likely be able to restore a balance to U.S. finances without crisis.
Those market forces, however, will also have an effect on stocks. What do you need to take into account in managing your portfolio?
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First, multinationals, companies with global brands and big tech stocks will probably benefit, because they get a lot of business overseas.
Small- and mid-cap stocks could be at a disadvantage, because they tend to depend more on home markets.
Commodities producers -- from gold mining stocks to oil -- will probably benefit because they are priced globally in a variety of currencies and their price in devalued U.S. dollars will therefore tend to rise.
Companies with pricing flexibility -- which means tech stocks, highly innovative companies, natural monopolies and tech -- will fare better than companies with slow growth in unit sales and limited pricing power.
It's hard to see long-term bonds prospering, however, in an environment that accelerates inflation and puts upward pressure on interest rates.
And even for the stocks that are helped, the short-term benefits of a weak dollar can turn sour if the currency's value keeps declining.
The plain fact is that the current U.S. budget deficit is unsustainable for more than a few years. In fact, the weak dollar will likely become a serious problem within the term of this Administration, unless President Bush does begin cutting the deficit, as he repeatedly insists he will.
Since this Administration remains committed to keeping taxes low, the likely results will be a squeeze on much domestic spending. In many cases, the real spending cuts will likely be deeper than those proposed during the election campaign.
Which sectors are winners and which are losers? Health-care companies would seem to face the toughest environment, since they face other cost pressures as well. Defense is on its own budget. But progress toward a balanced budget would bolster the stock market in general and financial services in particular.
Michael Sivy is an editor-at-large for MONEY magazine. Click here to receive Sivy on Stocks via e-mail every Monday.
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