Pros and Cons of a Strong Dollar
A strong dollar means the US Dollar (USD) is trading at a high value relative to other currencies. It means that one USD buys more of another currency. The opposite is a weak dollar, which means one USD buys less of another currency. A strong dollar is a relative term and not an absolute one because the value of the USD compared to other currencies fluctuates. Whether a strong or weak dollar is preferred depends on fiscal and monetary goals. However, a strong dollar has advantages and disadvantages for consumers, companies, and countries.
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Example of a Strong Dollar
For example, the USD and British Pound sterling usually trade at one USD for 0.60 to 0.65 GBP. The USD is considered weak when $1 buys less, e.g., 0.50 GBP. However, the USD is considered strong when $1 buys more, e.g., 0.80 GBP.
Similarly, the USD and Japanese yen typically trade at $1 between 100 and 110 yen. When $1 buys less than 100 yen, it is considered weak. On the other hand, when $1 buys more than 120 yen, it is considered strong.
Currency exchange rates vary daily. Their fluctuations have a significant impact on trade and consumer behavior. Therefore, a strong dollar has advantages and disadvantages.
Advantages of a Strong Dollar
Overseas Travel Is Cheaper
International travel is cheaper when the dollar is strong. Airline tickets, hotels, restaurants, and shopping are less expensive because $1 buys more in a foreign currency.
Similarly, expatriates working or retired overseas will do better if their income is in USD. Their cost of living will decline, and the price of real estate will also be lower. The 500k GBP flat is about $580,050 at an exchange rate of $1 to 0.86 GBP. It is obviously more expensive if the USD is worth less.
Imports are Less Expense
Consumer goods imported into the US are less expensive if the dollar is stronger than the overseas company’s local currency. Wine from France and designer clothes from Italy will cost less. For example, a 500 Euro suit should drop in price in dollars.
Lower import prices may reduce inflation because US manufacturers cannot increase selling prices to remain competitive. However, lower import prices may benefit manufacturers as raw materials are cheaper, lowering costs and improving margins. For instance, automotive components sourced from overseas may cost less for US assembly plants.
International Companies Benefit
International companies with significant US businesses will benefit. These companies have a greater percentage of sales in the US, and their revenue is in dollars. When the sales are converted to their local currency, they will see a boost in sales from favorable currency effects.
Investors outside the US will see higher returns because of a strong dollar. This occurs because the currency exchange will enhance every dollar of return. In addition, rising US interest rates faster than their home countries will lead to greater total returns for US Treasury bonds.
Disadvantages of a Strong Dollar
US Tourism is More Expensive
International tourists coming to America are at a disadvantage. This is because prices in their local currency are now higher, including airline tickets, hotels, restaurants, and shopping. For instance, 100 Japanese yen buys a lower quantity of US dollars when the latter is strengthening. This can significantly affect cities like Las Vegas and Orlando, which are dependent on tourism.
Similarly, foreigners paid in their home currency and living in the US will struggle because everything costs more when the dollar is strong. Therefore, their cost of living will increase.
Developing Countries with Weak Currencies
Developing countries issuing dollar-denominated bonds will be punished. This is because the bond interest payments are in USD, and a strong dollar makes it harder to service the debt as their local currency depreciates.
Countries that import oil, natural gas, and other commodities are also disadvantaged because these items are typically paid for in US dollars, making them more expensive.
Furthermore, emerging market countries requiring US dollar reserves will struggle to maintain those reserves since it costs more to acquire those dollars.
Exporters Are Impacted
A strong dollar negatively impacts American companies exporting overseas. Large US exporters must price their products higher to maintain profit margins. The higher sales prices may potentially make their product less competitive.
US Multinationals Are Affected
Large US companies with significant international business will earn less because of foreign currency headwinds. For example, some companies like McDonald’s (MCD), International Business Machines (IBM), Apple (AAPL), etc., have a large number of international sales. Those sales are worth less in USD, with a strong dollar possibly lowering profitability.
Americans investing in foreign equity or real estate markets will likely have lower returns. In addition, a strong dollar will cause a foreign exchange headwind to total returns.
Final Thoughts on the Advantages and Disadvantages of a Strong Dollar
Professional investors often make tactical changes when the dollar is strengthening or weakening. Moreover, exporters and multinational companies usually hedge currency effects. The average investor probably cannot easily counter the effect. The dollar may strengthen for a period, but eventually, it will reverse and weaken. Predicting dollar movements relative to other currencies is extremely difficult.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.