-By Dr. Carl Steidtmann, Chief Retail Analyst, Deloitte Research

You know things are getting ugly for the dollar when supermodels want to be paid in euros. It was recently reported, although later denied, that the world's top earning supermodel, Gisele Bundchen, only wanted to be paid in euros. She is not alone. Jim Rogers and Warren Buffet, two of the great global investors who are probably a lot richer but not nearly as good-looking as Bundchen, also announced that they are diversifying out of the dollar.
 
Faced with a Hobbsian choice between helping an ailing banking system whose balance sheets are loaded with bad debt or propping up the dollar on FX markets, the Fed has tried to save the banking system. In doing so, the Fed has lost the confidence of foreign investors. While the U.S. trade deficit requires more than $2 billion a day to finance, foreigners were net sellers of dollar-denominated assets to the tune of $69 billion in August, the largest single monthly decline in foreign holdings ever recorded.

In recent months, central bankers around the world have acted on their past stated desire to diversify out of the dollar. As foreigners have dumped the dollar, the greenback has lost more than 7 percent of its value in the past two months, 11.5 percent from a year ago.

U.S. Dollar Trade Weighted
The dollar is a commodity like any other. Its price is determined by supply and demand. A trade deficit increases the supply of dollars on foreign exchange markets. The U.S. runs a trade deficit in excess of $800 billion. The demand for dollars comes from investment demand. Higher interest rates relative to other foreign alternatives, faster profit growth or greater safety all attract foreign investment dollars.

By cutting interest rates in the face of weaker growth, the Fed is reducing the flow of investment into the U.S., undercutting the dollar and sending it lower. The perception of the U.S. as a safe haven for foreign investment has also been hurt by the balance-sheet problems of many U.S. money centers and investment banks. Given the credit problems in the U.S. and the relatively stronger growth overseas, the dollar will continue to decline.

A falling dollar has a lot of different economic effects, some positive, some negative. It will make U.S. exporters more competitive in global markets. The improvement in the U.S. trade deficit over the course of the next several years will offset some of the weakness in the domestic U.S. economy. A weaker dollar also gives a boost to globally traded commodities like gold and oil. Since the Fed started cutting rates in August, the price of oil has jumped more than $20 a barrel, and gold prices have soared from $650 to $840 an ounce.

Implications for Retailers
A weaker dollar will make life more difficult for retailers. Rising oil prices act much like a tax increase on consumers. Every penny increase in the price of gasoline takes roughly $200 million a week out of the pockets of consumers. Since oil prices began their rise in late August, gasoline prices are up 40 cents a gallon and are likely to go much higher. At a time when consumer finances were already under pressure from resetting home mortgages and a loss of mortgage refi money, rising gasoline prices further depress household cash flow available for more traditional retail spending.

A falling dollar will push up the cost of imported goods at a time when consumer spending is weakening. In the short term, the result will be a compression of retail margins. Over the longer run, retailers will be forced to find domestic alternatives to higher-cost imports. The result will be an improvement in the U.S. trade deficit and a rebalancing of the global trading system.

As the U.S. trade deficit falls, the share of Gross Domestic Product (GDP) going to consumer spending will contract. Between 2000 and 2007, GDP's share of consumer spending rose from 67.8 percent to 72 percent, a stunning 4.2 percent increase equal to $580 billion in consumer spending. The rise in GDP share pushed up retail stocks by 150 percent over the gains in broad market indexes.

As GDP share contracts, consumer spending will underperform the broad economy, depressing retailers' ability to create shareholder value, raise capital, open new stores and develop new concepts. Retailing will become a mature industry. Cost control will triumph over sales growth as the industry copes with weaker consumer spending, fewer stores, less inventory and fewer workers.

Comments? csteidtmann@deloitte.com