Personal Finance: Stronger Dollar: good or bad?

photo Chris Hopkins

The value of the U.S. dollar has rallied sharply, up nearly 15 percent since May when measured against a basket of other currencies. This is the highest exchange rate for the greenback since mid-2010. So what does that mean for American families and for the U.S. economy?

At the Bretton Woods Conference near the end of World War II, the world's major nations agreed upon a fixed exchange rate mechanism. Each country's currency was pegged to the dollar, which in turn was fixed relative to a constant quantity of gold (exactly 1/35 ounce). Global imbalances eventually rendered the gold standard unworkable, and in 1971 the fixed exchange regime was scrapped in favor of floating rates. Henceforth market forces would determine the appropriate quantity of yen or pesos to exchange for a dollar. We generally say the dollar is "strong" if it enjoys a relatively high value compared with other currencies.

Since the demise of the gold standard, it has been official policy to favor and promote a strong dollar. The benefits of this policy to American consumers are many. In our globally interconnected world, much of what we buy is imported from foreign trading partners. A stronger (more valuable) dollar makes the price of these imported goods cheaper and therefore more affordable for households to buy. Conversely, a weaker dollar implies higher prices for imports and an increase in inflation as each dollar buys less.

A stronger dollar also makes investments in the U.S. economy more attractive to foreigners. Profits earned in America can be repatriated back into more rupees or euros since by comparison these currencies are worth fewer dollars. That is, each dollar of profit buys more of the home currency when the dollar is strong. Additional foreign investment leads to more capital spending and greater productivity for American workers that eventually translate into higher wages.

The same is true for financial assets like bonds. Roughly half of the outstanding U.S. Treasury bonds are held by foreign governments, and their willingness to underwrite our monstrous fiscal debt and deficits is partly dependent upon the value of that debt. If the dollar weakens enough, foreign governments could lose their appetite for Treasury bonds as the value of their investments declines in local currency. The recent strengthening has made our debt securities more palatable and stoked demand overseas.

Of course, not every American benefits unequivocally from King Dollar. U.S. firms that depend heavily on exports face a headwind in terms of higher prices to their foreign customers in their own domestic currencies. U.S. manufacturers like Boeing and Caterpillar become less price-competitive and ultimately lose sales to cheaper rivals outside the United States as the relative value of currencies shifts. That can lead to lower production and fewer jobs for American workers.

The same is true of big American companies with large foreign operations like Apple, McDonalds or Coca Cola. Profits earned on their considerable overseas operations are converted back into fewer dollars, reducing margins and returns to shareholders.

As long as the economy continues to expand, a stronger dollar is desirable since it directly benefits households through greater purchasing power and lower prices for global commodities like oil that trade in dollars. Not everyone wins, but the majority of families are better off when a dollar goes further and the prices of essential goods decline. And given weakening economic trends elsewhere in the world, the upward march of the greenback seems likely to continue for a while.

Christopher A. Hopkins, CFA, is a vice president at Barnett & Co. Investment Advisors.

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