What Does A Strong Dollar Mean? Just before the coronavirus outbreak in 2020, it was estimated that the dollar was involved in 88% of all foreign exchange transactions. In fact, the greenback currently makes up more than half of the world’s foreign exchange deposits, with the dollar now considered the foremost global reserve currency.
While it’s not quite the strongest currency on the planet just yet – that accolade goes to the Kuwaiti dinar – it’s undoubtedly been rising ever higher of late. The denomination is seen as one of the safest currencies in existence, and it often takes on the mantle of a kind of financial redoubt in times of trouble and uncertainty.
Indeed, given the upheavals the world has experienced recently, the dollar has ascended to record heights. It achieved parity with the European Union’s Euro, and almost did the same with the British pound sterling too.
But what exactly does a strong dollar really mean for the U.S. and the rest of the world?
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What Makes A Currency Strong?
A country’s currency is strong when its economy is healthy and growing. This leads to higher demand for its money, which in turn raises its value. A country with a strong currency can also afford to buy more foreign products, boosting its inward trade flows to boot.
On top of that, political stability at home – and instability abroad – can also lead to a strong currency too. When investors feel confident about a country’s government and policies, they are more likely to invest their capital in that country’s assets and equities.
While these factors contribute to a strong dollar, they are not the only ones. Other things that impact the value of a currency include inflation levels and central bank policies.
Inflation erodes the purchasing power of a currency, so countries with higher inflation rates typically have weaker currencies. Central banks can also influence the value of a currency by buying or selling it on the open market or changing interest rates.
How Does This Affect The U.S.?
There are two main ways in which America benefits from a growing dollar.
First, imports to the U.S. become cheaper when the dollar is strong. This is due to American businesses enjoying greater purchasing power, allowing them to bring foreign goods into the country for less.
Secondly, American citizens also see an increase in their own spending power when overseas. This happens because a resurgent dollar means that each American greenback is worth more when exchanged for foreign currency. As a result, Americans can buy more goods when traveling abroad.
Naturally, the obverse of these two points is also true. A strong dollar makes exporting goods more expensive for American companies, and tourists and visitors from outside the U.S. are likely to spend less while staying in the country too.
What Does A Strong Dollar Mean For The Rest Of The World?
For America, there are both good and bad aspects to having a strong dollar domestically. However, for the rest of the world, the consequences tend to be far less equivocal.
For instance, America exports a vast quantity of products and services across the globe, and the price of all of these goods shoots up when the dollar strengthens.
In fact, when a strong dollar is coupled with high local commodity prices in countries outside the U.S., those countries can often face a double-whammy of problems.
For instance, places like Egypt and Turkey import many of the raw materials needed for day-to-day survival – and these products are already trading at multi-year highs due to Russia’s invasion of Ukraine.
However, to make things worse, these then have to be paid for in dollar-denominated prices at exchange rates that are already inflated and getting worse. This can stretch countries to breaking point and lead to severe economic and physical hardships.
Emerging Markets Hit The Hardest
Many governments in emerging countries issue bonds denominated in U.S. dollars. This is fine when the dollar is weak or stable, but it can become a real problem when it strengthens like it’s doing right now.
Take Argentina, for example. Its peso has devalued against the dollar this year, and prices in the country have doubled in a short space of time.
However, the nation has been issuing bonds in U.S. dollars, and its administration now owes a fortune when calculated in its local currency. To make matters worse, it’s also more difficult to obtain credit from the market due to spiraling interest rates too.
In addition, many poorer countries are not able to borrow funds in their own currency because lenders are unwilling to take on the risk that comes with underwriting these often volatile denominations. That means that these countries must promise to pay back their loans in dollars, regardless of how unfavorable the exchange rate happens to be.
There are also some second-order effects that take their toll on emerging markets when the dollar is strong. One of these affects how central banks around the world must keep up with U.S. Federal Reserve policy, especially when the Fed is putting up interest rates.
In essence, emerging economies must raise their rates to protect their currency and attract inward investment too. However, this stymies their own development, increasing the cost of homegrown borrowing, which will, in time, reduce government tax revenues and exacerbate issues further down the line.
International U.S. Companies Can Also Suffer Too
A strong dollar also negatively impacts American firms that do a lot of business worldwide. International income streams become less valuable, and unless these companies have managed to hedge their exposure to currency risk, their overall company profits will take a battering along the way.
Wrap-up
A strong dollar can be a double-edged sword for both the U.S. and the rest of the world.
However, when the greenback is on the rise, it usually implies America’s economy is faring well – and its many benefits typically balance out any unwelcome consequences that a strong dollar brings.
Unfortunately, the same can’t be said for other countries, who must always be vigilant and do their best to insulate themselves from the dollar’s rising dominance.
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