You may have noticed that since mid-2014, the U.S. Dollar has been gaining a lot of strength with its value rising versus global currencies, after getting crushed in late 2008 and bottoming out in 2011. I am sure you have heard about this trend via the news and in our weekly blogs, but I wanted to take the time to illustrate what this actually means, and could for the next year or so, and possibly beyond. With the U.S. almost alone in the world raising interest rates, this trend may be very persistent as foreigners sell their currencies and buy dollars to invest for higher U.S. rates. This is just simple supply and demand—more people want dollars (higher demand, price goes up), and fewer want the other stuff (price goes down).
When we say the dollar is “up”, I am referring to its exchange rate versus a basket of currencies. This includes the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc. Let’s delve into what the benefits of a strong dollar are, using travel as an example. Many of you may have already seen how far your buying power goes overseas, especially if you compare it to trips a few years ago. For instance, a trip to Europe will cost you less today than it did even in 2014. Also, if any of you have family or friends living overseas (either ex-Pats or U.S. citizens), they will see their cost of living go down, as well, if they are paid in greenbacks.
Next, imports are cheaper for companies that buy materials or products from offshore. Hence, manufacturing companies that buy raw materials can decrease their production costs and thus increase their supply they sell. Low prices for everything from oil to copper are one consequence of a strong dollar. U.S. consumers also benefit from lower prices on imported goods—everything these days from TVs to Hondas. Your BMW or Porsche will cost less in dollar terms. So go ahead take that test drive. See if the sales person at the dealership is smart enough to try to “close” you with this situation working in their favor; foreign companies that do commerce in the U.S. and this firms investors will also see a bump in their sales, and probably profits, as well. This works in that firm that earns profits, in Dollars, can then convert these greenbacks into more of a cheaper currency in their “home” country, resulting in larger gains.
Finally, the drawbacks are there is less tourism in this country due to increased cost to foreigners in their currency. This also impacts business travelers and foreigners living in the U.S. as their cost, business travel, and living expenses go up, respectively. But the big Kahuna—the dark side of the strong dollar forces—is the impact on large, multinational companies (like Caterpillar, Johnson & Johnson, and even Coke) that depend on a sizable percentage of foreign sales. Since they must sell in “local” (non-U.S.) currencies, they get fewer dollars for a given price in a foreign market, and can’t raise prices much without risking losing business to non-U.S. competitors without this currency problem. This cloud on corporate profits has been one of the drags on the stock market for a year or so now. It’s also one of the factors holding inflation down, and confounding the Fed a little.
There are, however, several bright sides to this: import prices and travel have become great bargains, non-U.S. stocks have become extremely cheap in dollar terms (and probably a great buy if you can be patient a few years), and, finally, it looks like stories of the greenback’s demise as the “King of Currencies” are a bit premature. China’s dreams and bluster of seeing the Yawn (forgive me, the Yuan) emerge as an alternate reserve currency will have to wait a long, long time, as the strength of the USD keeps its demand as the world’s wealth storehouse flying high.