What does a strong US dollar mean for other currencies?

Global financial markets have undergone a major transformation in recent years and the biggest surprise of this transformation is a strong comeback of a strong US dollar. At the beginning of 2017, the dollar was weak and analysts expected the weakness to continue through 2018.

Two years later, global financial markets are very different. The most trending theme in financial markets in recent months has been the strength of the dollar. This is because many have chosen to turn to the dollar as a safe haven during the coronavirus crisis. However, if the dollar strengthens, it means that other currencies weaken.

An overview of a strong dollar

A strong US dollar has several advantages and disadvantages. It benefits some but negatively affects others. The dollar is considered strong when it appreciates against other currencies in the foreign exchange market. A strengthening US dollar means it can buy more units of foreign currency than before. For example, a strong dollar benefits Americans traveling abroad but puts foreign tourists visiting the United States at a disadvantage.

Benefits of a strong dollar
Traveling abroad is cheaper

Americans holding US dollars can see those dollars last longer abroad, giving them a higher purchasing power abroad. Since local prices in foreign countries are not greatly affected by changes in the US economy, a strong dollar can buy more goods when converted into the local currency. Foreigners, or US citizens living and working abroad, will also see their cost of living decrease if they still own dollars or receive their income in dollars.

Imports are cheaper

Goods produced abroad and imported into the US will be cheaper if the manufacturer’s currency falls in value against the dollar. Luxury cars from Europe, such as Audi, Mercedes, BMW, Porsche and Ferrari, would all fall in price in the US if the dollar strengthens. If a European luxury car costs €70,000 at an exchange rate of $1.35 per euro, it will cost $94,500.

The same car sold for the same amount of euros would cost $78,400 if the exchange rate falls to $1.12 per euro. As the dollar continues to strengthen, import prices continue to fall. Other imports will also fall in price, increasing the disposable income of US consumers. US companies that import raw materials from abroad will have a lower total cost of production and report higher profit margins as a result.

Multinational companies doing business in the United States

Foreign companies doing a lot of business in the US and their investors will benefit. Multinationals that have large sales in the US and therefore have income in dollars will see gains in the dollar translate into profits on their balance sheets. Investors in these companies will also benefit.

World reserve currency status strengthened

The dollar’s status as a global reserve currency is enhanced by a strong dollar. While some countries, including Russia, Iran and China, have questioned the status of the US dollar as a global reserve currency, a strong dollar helps keep demand as a reserve currency at a high level.

While a strong dollar benefits Americans in many ways, it can also hurt US companies that do much of their business abroad and their investors.

Disadvantages of a strong dollar

Tourism to the US is more expensive

Visitors from abroad will find that the prices of goods and services in the United States become more expensive with a stronger dollar. Business travelers and foreigners living in the US but holding on to foreign bank accounts or receiving income in their home currency will be hit and their cost of living will increase.

Exporters suffer

Just as US imports are becoming cheaper, US-produced goods are becoming relatively more expensive abroad. An American-made car costing $30 000 would cost €22 222 in Europe with an exchange rate of $1.35 per euro; however, it increases to €26 786 when the dollar strengthens to 1.12 per euro. Some have argued that expensive exports could cost American jobs.

U.S. companies operating abroad are affected

US-based companies that conduct a large part of their business around the world will be hit because the revenue they earn from foreign sales will decrease in value on their income statements. Investors in such companies are also likely to see a negative impact on their shares.

McDonald’s Corp (MCD) and Philip Morris International Inc (PM) are well-known examples of US companies with a large share of their sales abroad. Some of these companies use derivatives to hedge their currency exposure, but not all of them do, and those that do hedge may only do so partially.

Emerging market economies are negatively affected

Foreign governments demanding US dollar reserves will pay relatively more to get those dollars. This is particularly important in emerging markets.

Specific considerations

Economic theory predicts that exchange rate fluctuations will eventually revert to a mean because cheap foreign goods should increase demand for them and raise their prices. At the same time, expensive domestic exports must fall in price as demand for these items declines worldwide until ultimately some equilibrium level of trade is found.

What a strong US dollar means for other currencies

Global financial markets have undergone a major transformation in recent years and the biggest surprise of this transformation is a strong comeback of the US dollar. At the beginning of 2017, the dollar was trading weak and analysts expected the weakness to continue through 2018.

Twenty months later, global financial markets seem very different. The most trending theme in financial markets in recent months has been the strength of the dollar, and there are signs that its rise may continue – at least for a while.

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