Aside from the past three years, during which the dollar has fallen approximately 37% before inflation, the dollar has strengthened considerably since its trough in 1995. This recent decline has occurred mostly against the Euro. Against a basket of currencies, the dollar has declined approximately 15%.

Nevertheless, a sharp decline in the dollar is worrisome. It may create a major shock to our economic system. While the federal government continues to spend us into another nearly $500 billion deficit in addition to our trade deficit which for the current year will probably exceed $600 billion, there could be other consequences. They include:

1. Higher inflation due to the fact that the foreign goods that we so frequently import will cost more.
2. With higher inflation, the Fed will undoubtedly raise interest rates.
3. Higher interest rates will probably slow down the economy.
4. A decline in the U.S. dollar would mean that foreign investors would not want to hold U.S. investments. Currently, foreign investors own approximately 11% of U.S. equities and buy 40% of all newly issued U.S. government securities.
5. The stock market will become even more lethargic and will possibly decline in value. From 1985 to 1987, the U.S. dollar declined approximately 50% which culminated in the 1987 stock market crash.

U.S. companies will be able to raise prices as foreign goods producers face increased price pressures due to the increased prices in selling to U.S. consumers as a result of a declining dollar. Over the long run, a declining dollar would stimulate U.S. economic activity by improving U.S. competitiveness. A weaker dollar would cause foreigners to buy more U.S. goods and U.S. consumers less foreign goods. However, this economic growth will probably take at least a year, more likely longer.

Generally, U.S. companies that do not have large foreign operations but sell goods abroad will benefit the most. Their goods will become less expensive; therefore, exports will increase. U.S. companies that have large foreign operations will in all likelihood not be impacted or will be negatively impacted. Companies that have the bulk of their sales and operations in the U.S. will probably be unaffected except that foreign competition selling goods in the U.S. may be selling their goods at higher prices.

In the short run, as the U.S. dollar declines, U.S. consumers, the stock market, the bond market and the economy will be negatively impacted. Longer-term, U.S. consumers, the economy and some U.S.-based companies will benefit. Naturally, this does not occur overnight. The U.S. government must take the painful first step of cutting spending and raising taxes. Only by narrowing the federal budget deficit and perhaps even balancing it can we avert major shocks to the economy.

For further information about evaluating the quality of a company’s earnings, call LOUIS P. STANASOLOVICH at (412) 635-9210.