As the U.S. economy has emerged from the Great Recession and grown, the strength of the U.S. dollar has also improved. The PowerShares DB US Dollar Index ETF (UUP) is up more than 17% over the past 12 months and 4.25% year-to-date. This index 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.
While a stronger dollar benefits some, it negatively impacts others. Here is a list of the pros and cons of a strong U.S. dollar.
Pros of a Strong Dollar
Traveling abroad is cheaper. Americans holding U.S. dollars are able to 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 stuff when converted to the local currency. With the dollar strong and the euro relatively weak due to the lingering sovereign debt crises, U.S. tourists in Europe can find a more affordable vacation than if they traveled two or three years ago. Ex-patriots, 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 when compared to the dollar. Luxury cars from Europe, such as Audi, Mercedes, BMW, Porsche, and Ferrari will 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 will 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 and inputs from abroad will have a lower total cost of production and enjoy larger profit margins as a result.
How To Trade The Falling Dollar
Foreign companies that do a lot of business in the U.S. and those companies' investors will benefit. Multinational corporations who have a large number of sales in the U.S., and therefore earn income in dollars, will see gains in the dollar translate to gains on their balance sheets. Investors of these companies should be rewarded as well. German pharmaceutical company Bayer has reported that each 1% appreciation of the dollar against the euro increases net sales by €260 million. European aircraft giant Airbus enjoys a $1 billion boost in profits for every 10% increase in the dollar, and chemical maker BASF earns an additional €50 million for every percent the dollar rises.
The status of the dollar as a world reserve currency is bolstered. 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.
Cons 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 U.S. 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.
Exporters suffer. Just as foreign 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, but increases to $26,786 when the dollar strengthens to 1.12 per euro. Some have argued that expensive exports can cost American jobs. (See also: How You Can Benefit From a Weak Euro.)
Domestic companies that do a lot of business abroad will be hurt. Companies that are based in the United States but 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. McDonalds (MCD), Coca-Cola Enterprises (CCE), and Philip Morris (PM) are all well-known examples of U.S. 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.
Foreign governments who require U.S. dollar reserves will end up paying relatively more to obtain those dollars. This is especially important in emerging market economies.
The Bottom Line
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 its sales have been hurt. Economic theory predicts that currency fluctuations will eventually revert to a mean due to the fact that 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.