Consequences of a Strong U.S. Dollar

April 4, 2023

Over the past year the U.S. Dollar has rebounded in the foreign exchange market, on track to have its best year since 1984. The DXY US Dollar Currency Index – which measures the value of the U.S. Dollar relative to foreign currencies like the Euro, Swiss Franc, and Pound Sterling – is up nearly 17% from last year as of October 2022, and the consensus among analysts is that the trend will continue to skyrocket.

Economists believe that the recent increase in the value of the dollar is best attributed to higher inflation and interest rate expectations. As inflation continues to rise, the less valuable the dollar becomes, the more likely it is that Jerome Powell’s Federal Reserve will raise the federal funds rate. With each hike in interest rates, the dollar becomes more attractive to investors as they can obtain higher returns on bonds and interest-rate products like swaps, caps, and collars. Having said that, what are therefore the consequences of a strong dollar? For one thing, it makes imports cheaper because each dollar is worth significantly more relative to the world’s other currencies, allowing Americans to purchase goods at lower prices. As stated in the Bureau of Labor Statistics’ monthly release of the U.S. Import and Export Price Indexes, U.S. import prices fell 1.2% in September, after falling 1.1% the previous month and 1.4% the month before that. Consequently, the United States is importing deflation and providing some relief to consumers from higher prices.

A strong dollar not only benefits American consumers, but also  tourists visiting the country. It benefits American travelers since favorable currency exchange rates grant them more purchasing power, which means they have more money to spend when traveling abroad. For instance, earlier this year, the dollar reached its highest level in two decades against the Euro, culminating in a significant rise of American tourists and their financial activity in the continent. Nonetheless, a surge in the price of the U.S. dollar is not entirely positive. According to CNBC, “a strong dollar crimps income that companies earn abroad, since money brought in in the form of weaker foreign currencies is converted into fewer dollars.” The effects of this can be felt in the stock market knowing many of the exchange’s listed companies operate in multiple countries, and if they report lower earnings because of the dollar’s recent growth, their stock price may fall. To visualize this, consider an American company that sells cabinets in the Turkish market and must convert each Turkish Lira in revenue back to domestic currency. If the price of the dollar continues to accrue, the company will either be forced to raise prices and lose customers or operate at a loss until the price of the dollar cools. If it chooses the second option, it is almost certain that they will report lower revenues on their quarterly earnings report, causing their stock to fall.

In addition to international corporations, a strong dollar also affects people in low-income countries. This is due to the fact that the dollar is the world’s reserve currency, and thus a large portion of international trade is dependent on American currency as a means of exchange; when the price of the dollar rises, it becomes increasingly difficult for many third-world countries to afford everyday goods as imports become more expensive. This threatens many developing nations with high poverty and famine rates including Ethiopia, Nigeria, and South Sudan. Taking this into account, it is unlikely that the dollar will cool off, as the current exponential escalation is primarily driven by the Federal Reserve’s interest rate hikes, which will continue until inflation is tamed. As Sir Isaac Newton said it best in his Third Law of Action and Reaction: “for every action in nature there is an equal and opposite reaction.” The U.S. Dollar is no exception. 

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