Strong Dollar: An Overview
A strong U.S. dollar has several advantages and disadvantages. It benefits some but negatively impacts others.
The dollar is considered strong when it rises in value against other currencies in the foreign exchange market. A strengthening U.S. dollar means it can buy more of a foreign currency than before. For example, a strong dollar benefits Americans traveling overseas but puts foreign tourists visiting the U.S. at a disadvantage.
The Invesco DB U.S. Dollar Index Bullish Fund (UUP) was up nearly 4% for the year at the end of 2019. This exchange traded fund tracks an index that represents the value of a dollar compared to its exchange rate versus a basket of important foreign currencies, including the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.
- A strong dollar is good for some and relatively bad for others.
- With the dollar strengthening over the past year, American consumers have benefited from cheaper imports and less expensive foreign travel.
- At the same time, American companies that export or rely on global markets for the bulk of sales have been hurt.
Advantages of a Strong Dollar
Traveling Abroad Is Cheaper
Americans holding U.S. dollars can see those dollars go further abroad, affording them a greater degree of buying power overseas. Because local prices in foreign countries are not influenced greatly by changes in the U.S. economy, a strong dollar can buy more goods when converted to the local currency.
Expatriates, or U.S. citizens living and working overseas, will also see their cost of living decrease if they still own dollars or receive dollars as income.
Imports Are Cheaper
Goods produced abroad and imported to the United States will be cheaper if the manufacturer's currency falls in value compared to the dollar. Luxury cars from Europe, such as Audi, Mercedes, BMW, Porsche, and Ferrari, would all fall in dollar price. If a European luxury car costs €70,000 with an exchange rate of 1.35 dollars per euro, it will cost $94,500. The same car selling for the same amount of euros would now cost $78,400 if the exchange rate falls to 1.12 dollars per euro.
As the dollar continues to strengthen, the price of imports will continue to fall. Other lower-cost imports will also fall in price, leaving more disposable income in the pockets of American consumers. U.S. companies that import raw materials from abroad will have a lower total cost of production and enjoy larger profit margins as a result.
How To Trade The Falling Dollar
Multinationals That Do Business in the U.S. Benefit
Foreign companies that do a lot of business in the U.S. and their investors will benefit. Multinational corporations that have a large number of sales in the U.S., and thus earn income in dollars, will see gains in the dollar translate to gains on their balance sheets. Investors in these companies should be rewarded, as well.
Status as World Reserve Currency Is Bolstered
The status of the dollar as a world reserve currency is bolstered with a strong dollar. While some countries, including Russia, Iran, and China, have questioned the status of the U.S. dollar as the de facto world reserve currency, a strong dollar helps keep its demand as a reserve high.
While a strong dollar benefits Americans in many ways, it can also hurt domestic companies that conduct a lot of their business overseas and their investors.
Disadvantages of a Strong Dollar
Tourism to the U.S. Is More Expensive
Visitors from abroad will find the prices of goods and services in America more expensive with a stronger dollar. Business travelers and foreigners living in the US but holding on to foreign-denominated bank accounts, or who are paid incomes in their home currency, will be hurt and their cost of living increased.
Just as imports become cheaper at home, domestically produced goods become relatively more expensive abroad. An American-made car that costs $30,000 would cost €22,222 in Europe, with an exchange rate of 1.35 dollars per euro; however, it increases to €26,786 when the dollar strengthens to 1.12 per euro. Some have argued that expensive exports can cost American jobs.
US Companies Conducting Business Abroad Are Hurt
Companies based in the United States that conduct a large portion of their business around the globe will suffer as the income they earn from foreign sales will decrease in value on their balance sheets. Investors in such companies are also likely to see a negative impact.
McDonald's Corp. (MCD) and Philip Morris International Inc. (PM) are well-known examples of US companies with a large percentage of sales occurring overseas. While some of these companies use derivatives to hedge their currency exposures, not all do, and those that do hedge may only do so in part.
Emerging Market Economies Are Negatively Impacted
Foreign governments that require US dollar reserves will end up paying relatively more to obtain those dollars. This is especially important in emerging market economies.
Economic theory predicts that currency fluctuations will eventually revert to a mean since cheap foreign goods should increase the demand for them, raising their prices. At the same time, expensive domestic exports will have to fall in price as demand for those items declines worldwide until, ultimately, some equilibrium exchange level is found.