A strong dollar is a reflection of the American dream, especially when you realise that the US is able to throw its weight around because of the bite a strong dollar can have on weaker economies.
When the US dollar rises, it’s usually a good thing – strength is virtuous, after all. But a strong dollar is not always a good omen. Too much starts to happen under the hood until it manifests as undesirable outcomes, such as significant volatility in the stock market.
So, who benefits most from a strong dollar and who would prefer that the dollar stays weak? Understanding both perspectives by exploring the underlying reasons is really important and is the aim of this article.
What is a “Strong Dollar?”
A valuable foundation for this discussion is defining what the term “a strong dollar” means.
A strong or weak dollar are ways to describe the value of the US dollar when compared with the value of other currencies.
Whether the dollar is strong or weak has important implications for the local stock market, foreign investment, tourism, and the US economy.
Implications of a Strong Dollar
When you hear in the news or financial analysis that the dollar is strong, in simple terms, it means that the US currency has appreciated in value to a point close to or at historically high levels relative to other currencies.
With a strong dollar, you can buy more of other (or foreign) currencies than you previously could. Of course, when you are able to buy or afford more of another country’s currency, you can afford more of the goods produced in that country. This obviously benefits Americans, but does it benefit you living in another country?
A strong dollar diminishes the incentives available to foreign tourists visiting the US. These travellers have to spend more to buy every American dollar they need to use while staying on US soil.
Therefore, in terms of sheer monetary value, a strong dollar is an advantage to the American-based individual. In contrast, those living elsewhere or who want to travel to the US will be smiling less when buying US goods and services.
The Invesco DB US Dollar Index Bullish Fund (UUP) is an exchange-traded fund tracking an index that represents a dollar’s value relative to its exchange rate compared with important foreign currencies such as the British pound, Canadian dollar, EU euro, Japanese yen, Swedish krona, and Swiss franc. As of year-end 2019, it was up nearly 4 per cent.
Let’s have more concrete illustrations to make this clearer.
1. Cheaper Imports
You already know about the price dynamics that play out when the dollar becomes stronger. US imports produced abroad will become cheaper and more affordable. Americans can then buy more luxury car brands from Europe, including Audi, BMW, Ferrari, Mercedes, and Porsche. The dollar price of their products will fall, and Americans can snap them up faster.
Thus, a European luxury car normally costing €70,000 will now go for €94,500 at an exchange rate of $1.35 to the euro.
If the exchange rate drops to 1.12 dollars per euro, that same car will cost $78,400 for the same amount of euros. Interesting, right?
The stronger the dollar, the lower the price of imports. Other lower-cost imports will also fall in price, allowing US residents to have more disposable income in their pockets.
US companies will also benefit in that they will import foreign raw materials at a lower total cost of production and ultimately enjoy larger profit margins.
2. Multinational Companies Operating in the US Will Benefit
Many foreign companies do business in the US. These companies and their investors are often happy for a strengthening dollar. If they have much sales in the US, they earn more income in dollars.
These dollar gains on their balance sheets mean their investors can expect to receive even bigger dividends when stronger sales accompany a stronger dollar.
3. Greater Trust in the Dollar as World Reserve Currency
The dollar maintains an enviable status as the world’s reserve currency. When it rises in value (that is, it becomes stronger), this reputation and status strengthen too.
China, Iran, Russia, and a few other countries have questioned the rationale for keeping the US dollar as the world’s reserve currency
However, this opposition has barely dented the reputation of the dollar, and the stronger the dollar is, the greater the demand for it as a reserve currency.
Downsides of a Strong Dollar
1. Local US Businesses Will Pay a Price
It’s worth noting that while a strong dollar is a strong incentive for US businesses, domestic US companies and their investors operating overseas will have to face a unique set of challenges because of this.
2. US Companies Operating Abroad Will Suffer
Any US-based companies that do a lot of business abroad will suffer since the income from their non-US operations will lower in value. Again, it’s because their income from foreign sales will decrease in value on their balance sheets. As a result, investors in these companies will likely see a negative impact.
McDonald’s Corp. (MCD) and Philip Morris International Inc. (PM) are two US companies with plenty of overseas sales. Companies like them typically use derivatives to hedge their currency exposures – whether in whole or in part. Others may not use this tactic to preserve the value of their earnings.
3. Exporters Bear the Brunt
As imports become cheaper to buy, domestically produced goods also become more expensive to ship and purchase abroad.
A US-made car costing $30,000 will cost €22,222 in Europe if the exchange rate is 1.35 dollars to the euro. This price would go up to €26,786 if the dollar bulks up to 1.12 per euro.
Expert arguments opine that expensive exports can hurt US jobs – a down-to-earth assessment by any standards.
4. Tourism to the US Will See Some Drought
During dollar-rising season, visitors to God’s own country will find prices are more expensive with a stronger dollar.
Business travellers and expatriates in the US who maintain foreign-denominated bank accounts or paid incomes in their country’s currency will have to endure a higher cost of living.
5. Uncommon Scenarios
According to economic theory, currency fluctuations eventually fall back to a mean because cheap foreign goods grow in demand, leading to higher prices for the respective goods.
In the same vein, expensive domestic exports will fall in price in response to the global demand decline.
This cycle continues until some equilibrium exchange level happens.
A rising dollar can have positive or negative effects, depending on who is involved and what’s at stake.
In terms of the currencies of US trade partners, imports become cheaper, but exports concurrently become more expensive for foreign buyers.
The state of the economy is important to determine if either of these circumstances is good or bad. If there’s little capacity utilisation and high unemployment, it’s likely a net negative. The trade effects in these circumstances won’t help the economy emerge from recession and could worsen it instead.
From a broad macro perspective, a stronger dollar is better for the local population as it improves their terms of trade with countries worldwide. Thus, the US gets more imports – trade benefits – per dollar (cost of trade).
Note: Please do not invest money or assets in the financial markets that you cannot afford to lose. This article should not be construed to be investment advice and is for information purposes only