Question: Can you explain what is meant by a “strong dollar?” How does this affect consumers, the economy, and the stock market?
Answer: Your question is not only well timed; it should be on an Economics College Final exam! The U.S. Dollar (USD) index is a commonly used, and often misunderstood, measure of the strength of our currency, the USD, relative to the currency of other countries. Common sense indicates that it is good news if something is “up.” Before making that assumption, it may help to explain how U.S. Dollar valuation is measured and why it exists.
History of the US Dollar Index
As World War II was winding down during 1944, the forty-four Allied Nations gathered 730 representatives at The Mount Washington Hotel in Bretton Woods, NH to discuss how to pay for reparations and rebuilding when the war ended. They agreed to establish an International Monetary Fund Foundation (IMF) to provide advice and assistance to member countries. At that time, the United States controlled two-thirds of the world’s gold with the US Dollar valuation pegged to the price of gold. Therefore, the IMF chose the USD as the reserve currency. Soviet leaders were at the conference but didn’t agree to these terms or participate.
As WWII ended, economies around the world began to grow. The United States’ share of world economic output dropped from 35% to 27% while other countries gained. In the early 1960’s, the U.S. committed troops to Vietnam, increasing our debt load while other IMF countries expanded their economic output. By August 1971, the US Bureau of Labor statistics reported
U.S. unemployment and inflation rates of 6.1% and 5.84% respectively.
Not surprisingly, participants of the Bretton Woods’s agreement became concerned about the future of the U.S. economy and either left the system or converted their USD into gold. On Friday, August 13, 1971, President Nixon, with the support of his advisors, discontinued The Bretton Woods Agreement. Holders of U.S. dollars could no longer convert these notes into gold. Since that time, the value of the dollar has not officially been tied to anything, effectively free-floating and dependent upon foreign exchange rates and prices of other commodities such as oil to determine a value.
The USD Index measures the value of the dollar relative to the currencies of Canada, Eurozone, Japan, Great Britain, Switzerland and Sweden. In 1973, the index base was 100 ultimately reaching a high of 164.7200 in February 1985, and a low of 70.698 on March 16, 2008. During the past fifty-two weeks, the index swung from 78.90 on May 8, 2014 to 100.39 on March 13, 2015.
Economic Pendulum Swing
So why is the dollar up so much in the past twelve months? The answer is simply supplyand demand. More investors want to own US Dollars than are willing to sell them, so greater demand drives the index up. Global growth slowdowns are a concern and many countries have decreased interest rates to near zero (or in some cases into negative territory) to create cheap or easy money conditions to stimulate growth. Through their own monetary policy actions, these countries have effectively devalued their currencies relative to the USD.
Consumer and the markets
A rising USD increases the cost of our exports in terms of other countries’ currencies. Translation: they pay more for our goods or services. When all things are equal, higher costs on exports typically reduces export activity. A stronger USD can be a hindrance for corporate earnings and stock valuations when corporate sales go down. Meanwhile, imports may appear more attractive to those of us who are U.S. centric because their products are relatively less expensive. As always, there are exceptions to the rule including those companies like transportation that may benefit from reduced exports, increased imports and lower oil prices. Are you confused yet? This is why it is so important to know what you own and understand how your portfolio is designed.
For years, the U.S. Treasury asserted that a strong USD is good for our economy. Global investing has become much easier and international business expands with use of the internet. This changes the relationship between the USD and the stock market. Prior to 2000, the USD and the S&P 500 had a strong positively correlated relationship meaning that if either one went up, so did the other. The importance of the U.S. home field advantage has dissolved over the last fifteen years.
We don’t know yet if the strong dollar is causing real damage to the economy and if the current momentum is attributed to traders overreacting or underlying currency issues. Most likely, it’s a mix of both. Whether it’s traders who are bidding up the dollar or grandkids spending too much time in the sun during spring break, some people don’t quit until something is overdone. Stay focused and invest accordingly.
The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.
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This article provided by Darcie Guerin, CFP®, Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email firstname.lastname@example.org Website: www.raymondjames.com/InvestmentInsights