Oct 2017

What’s (not) in a Word: Strong Dollar

By Joe Day
October 27, 2017



Economics is a numerical discipline. Economists count things, measure their value, calculate ratios between those values, and project how the counts and values will change over time. But to communicate economic ideas, we rely largely on language.

And for the most part, language is very useful for this purpose, because language is a powerful tool. Sometimes, however, language’s very power can overwhelm the concepts it is supposed to communicate, and distort our understanding of the underlying economics.

Consider how we describe the value of the dollar relative to other currencies. The dollar is “strong” against a foreign currency if it buys more of that currency then it has in recent history, and “weak” if it buys less.

You can see this dynamic in the following chart, which tracks the history of the euro and the dollar—specifically, how many euros you could buy with one dollar since the euro was launched in 1999. Back then, one dollar would buy about 0.9 euros. Over time, it “weakened” to a low about 0.6 euros, and has gradually “strengthened” since then.

Of course, “strong” is always better than “weak,” right? Since the dollar is our national currency, the terminology strongly suggests that we want a strong dollar. But that depends very much on who you ask.

Imagine you are a U.S. based manufacturer, for example. You make high quality widgets that are very popular with wealthy Europeans (everyone knows that Europeans appreciate fine widgets more than Americans). So you sell most of your widgets in Europe, and as a result, and this is the key, you get paid in euros. Nearly anyone selling into foreign markets has to accept the currency of that market, just as you expect to be able to pay dollars for a bottle of French wine down at your local BevMo.

So if you are selling widgets to Europeans (perhaps at their local WidgMo) you have to take euros. Those colorful euros are of little use to you in America, so before you can spend them, you convert them to sensible green dollars. If the dollar is strong against the euro, as it was last December, it takes 0.96 of those euros to buy just one dollar. But if the dollar is weak against the euro, as it was in 2008, you only need 0.63 euros to buy a dollar. Which do you prefer? The weak dollar, of course, because you get so many more dollars for each euro you receive from your European customers. And you are not alone. U.S. exports totaled $2.2 trillion in 2016, and the weaker the dollar, the more those exports are worth to their U.S. producers.

Likewise, and closer to our business here at BMC, if you own stocks in foreign companies, or hold foreign currencies directly, the value of those investments to you will increase as the dollar weakens. Indeed, most foreign investments in our clients portfolios have gained all this year independently of their underlying fundamentals, simply because the dollar has weakened against most foreign currencies.

On the flip side, if you are a U.S. manufacturer that uses raw materials sourced from foreign countries, but sells your goods here in the U.S., you want a strong dollar, so you can buy raw materials cheaply. Similarly, if you like buying foreign made widgets—or cars, or wine, or fancy cheeses—a strong dollar makes those goods cheaper here in the U.S.

The better situation for the U.S. as a whole depends on the stage of the business cycle, the balance of imports vs. exports, and a host of other factors that can change over time. Reasonable people can and do disagree about how to balance those factors, depending on what schools of economics and politics they follow. What does not matter in the slightest is the label. There’s nothing about “strong” and “weak” that is mandated by the economics. We could just as easily describe a strong dollar as an “import” dollar, and a weak dollar as an “export” dollar.

But there are consequences to those labels nonetheless. There’s a natural, if baseless, tendency to favor a strong dollar over a weak one. No sensible politician will tell constituents they should send him or her to Washington to enact weak dollar policies. So the next time you hear a politician, or anyone, discuss “strong” versus “weak” dollars, try replacing their terms with “import” dollar and “export” dollar, and see if the claims being made hold up just as well.

This entry was posted on Friday, October 27th, 2017 at 04:59 pm and is filed under BlogEconomy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.


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bio3Joe Day, CFA is the Founder of Bear Mountain Capital. Joe started the company after spending many years advising high net worth clients with a leading global wealth management firm. Joe earned the right to use the CFA designation from the CFA Institute in 2011. He also holds a degree in Business Administration, with a Major in Finance from Gonzaga University.

Luke Collova is an Investment Advisor Representative for Bear Mountain Capital focusing on planning, investment strategy, client development and operational support. Luke’s prior career included providing commercial insurance coverage for a global insurance firm. Luke maintains his Series 65 license and holds a degree in Business Administration, with an emphasis on Finance and International Business from the University of Puget Sound.