The dollar has been gaining strength against other currencies this year. But is that a good thing?
Any change in an economic indicator can be good news or bad news, depending on the context. We are in highly unusual times and an indicator of health in one context may reveal illness in another.
It is sort of like a doctor checking body temperature. A rising temperature often indicates some disease or infection. But if the patient was pulled from a freezing lake and is suffering hypothermia, a rising core temperature may be good news.
To return to the currency comparison, the dollar buys 17 percent more euros than it did at the beginning of the year. It buys 34 percent more British pounds and 39 percent more Brazilian reals.
A currency that gains value against other nations’ money may indicate good things. For example, if a country exports a great deal and imports little, its currency may become more expensive.
If its economy is productive, with high returns on business investment, investors from other nations will want to get in on the action. Their inward investments will bid up the price of the prosperous nation’s currency.
But a “stronger” currency can also indicate problems. The dollar gained value against other currencies in the early 1980s because U.S. interest rates were higher than elsewhere. But this was not because of high business profits. Rather, high rates resulted from the Federal Reserve raising interest rates to unprecedented levels to choke off the inflation that had become endemic in the 1970s.
The “strong” dollar was great for consumers. Imported cars and electronics were cheap. But it was a body blow to U.S. farmers as their foreign markets shrank. Ditto for steel and auto producers as imports burgeoned.
Today’s higher-valued dollar stems in part from reduced imports as U.S. households cut spending as they anticipate tough economic times. Slowing business also cuts imports.
Capital flowing into our country also is increasing the value of the dollar. But it is not coming here in search of high returns from a prosperous economy. Rather it is caused by financial firms liquidating investments abroad as they scramble to meet needs for cash here. Often they are dumping assets abroad at a loss just because their financial plight is so extreme. The resulting higher-value dollar reflects the perilous condition of financial markets, not a strong U.S. economy.
The stronger dollar is helping lower the price of oil and other imports. As in the early 1980s, that is good for consumers. But, as in that era, it is hammering U.S. farmers and auto producers. At the end of last week, the dollar cost of a Swedish Volvo or Saab was a third less than in January. Brazilian soybeans are a third more competitive.
If you are a consumer, appreciate lower prices. If a producer, hope to ride it out. But don’t be confused into thinking that the expensive dollar is unalloyed good news.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.