Consequences of a Strong Dollar

The value of the U.S. dollar relative to other world currencies has grown by approximately 22% in the past year. That means if the average investor outside the United States bought a U.S. stock in dollars one year ago and the stock purchased stayed flat (did not go up or down), that foreign investor would show a gain of 22% on average just because the U.S. dollar appreciated 22%. This demonstrates the principle that investors want to invest where the local currency is strong.

This dollar strength is helping exporters in weaker economies like Europe because the dollar goes a long way in purchasing goods and services denominated in Euros as the Euro gets weaker. It is common to hear people on Wall Street say that this is the time to book your vacation in Europe because the U.S. dollar will convert into many more Euros than it did a year ago.

Unfortunately for the emerging economies of the world, they are being hurt by dollar strength. The March 21 issue of The Economist reports that emerging market countries have borrowed $4.5 trillion in dollar-denominated debt. As the dollar gains in strength, emerging market currencies are growing weaker, and the debt in dollars becomes more and more expensive to service. This creates economic drag and uncertainty for emerging market countries.

The March 25 issue of The Wall Street Journal reports that African nations are being hit especially hard by the strengthening dollar and the decline in commodity prices. Shopkeepers throughout Africa cannot afford to import goods to stock their shelves.

The relative strength of America is highlighted by Europe and Japan being stuck in neutral or first gear and China, along with other emerging markets, slowing. The International Monetary Fund predicts that the U.S. economy will grow by 3.6% in 2015. With our Federal Reserve preparing to raise interest rates as other central banks are going the opposite direction, this all leads to the consequence that investors make higher returns in dollar-denominated assets.

25% of profits earned by S&P 500 firms are earned in foreign currencies. A stronger dollar causes these goods and services to be more expensive and less competitive. The stronger dollar will hurt foreign earnings by U.S. companies. Ironically, dollar strength mutes inflation because foreign goods and services are less expensive in dollar terms. Inflation is driven by goods and services becoming more expensive. Inflation in the U.S. year-over-year is -0.1%, while core inflation (excluding food and energy) is +1.6%. This is still well below the Federal Reserve target of 2% inflation as a cause for raising interest rates. The Fed may continue to talk about raising interest rates, but they may not act, because inflation under 2% does not call for higher rates.

Conclusion: Invest in the relative strength of the USA. Invest where the currency
is strong.

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