Shrinking U.S. dollar proves to be a double-edged sword

The credit squeeze is confining many high-leverage buyers to the sidelines in the United States, but international equity players will likely take up at least some of the slack in 2008. Due to a declining U.S. dollar, investors have seen their buying power in the U.S. increase as much as 30% in the past six months.

“It's made American real estate look like a screaming bargain to people with European or Canadian currency,” says Dr. Mark Dotzour, chief economist at the Real Estate Center at Texas A&M University.

The dollar has declined against the European currency for five of the past six years, equaling just 0.68 euros in November. That same month, the Canadian dollar had climbed to $1.07 U.S. from about 85 cents last spring.

That helps to explain why Canada's TD Bank Financial Group readily agreed to buy New Jersey-based Commerce Bancorp for $8.5 billion this fall. “They're buying Commerce Bank for 20% to 25% less than it would have cost them just a few months ago,” says Dr. Sam Chandan, chief economist at data researcher Reis.

The Fed's decision to lower short-term interest rates on Oct. 31 further depressed the dollar against other world currencies. Why? Essentially, smaller yields on U.S. Treasuries and the increased prospect of inflation make dollar-denominated investments less desirable. In addition, the Fed's action confirmed fears that the housing-worn U.S. economy needed help to avoid recession, and that knowledge erodes confidence in the domestic economy as a safe haven for investments.

Still, the weak dollar is a boon to manufacturing exports, fueling a 23% increase in output in the third quarter and contributing 1.73% to the overall GDP rate of 3.9%.

Some economists fear that concern over the crumbling U.S. housing industry and subsequent financial market turmoil will sour international investors and foreign central banks on U.S. securities. On Nov. 18, for example, Iranian President Mahmoud Ahmadinejad said OPEC members are considering diversifying their cash reserves away from U.S. dollars, which he called a worthless piece of paper.

But for now, China and other nations continue to reinvest billions of dollars in U.S. Treasuries, which has helped to keep long-term interest rates low and fueled economic expansion here. A reversal of that trend would pressure interest rates to climb and could lower prices on U.S. assets, including commercial real estate.

“When the people that have control over international wealth decide that they want less of that wealth in the U.S. and put it elsewhere, like in euros, that's a very serious consequence,” says Dr. Julian Diaz III, chair of real estate at Georgia State University.

On a brighter note, Dotzour of Texas A&M says domestic real estate investors needn't convert to euros to avoid losses in 2008. “If there's anything in the U.S. that's a real hedge against runaway, central-bank-induced inflation, it's good-quality commercial real estate or land.”
— Matt Hudgins