If you spend any time watching the financial news stations, or reading the financial press, you’ve been deluged by stories about the strength of the U.S. dollar. Most reports call dollar strength a headwind, and to some segments of the economy, it is. But like seemingly everything involved with economics, there is a counterpoint as well. It’s the old story about President Truman looking for a one armed economist so he couldn’t say “On the other hand.”
An excellent example of this was a recent article by Robert McTeer, the former Dallas Federal Reserve president. When asked whether a strong dollar is a good thing or a bad thing, he said “It depends.” As much as I hate to go along, it really does depend. So let’s look at both sides of the issue to determine what’s good or bad for you and the effect on your investments.
The dollar and all other major currencies used to be tied to gold, but all that changed in 1971 when President Nixon declared the gold backed system over. It’s a long story, but it turned out to be one of the biggest mistakes in economic history. Since then, any country could print as much of their currency as they wanted. Of course, more money chasing the same amount of goods is inflationary and that’s why inflation rose 50 percent in the late 1970s.
At any rate, the dollar was separated from gold and a new method of evaluation had to be found. The answer was the U.S. Dollar Index (USDX) which was established in March of 1973 with a base value of 100. The USDX measures the dollar against a basket of currencies that include the euro, the yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc. The Chinese yuan will be the next to join.
The USDX is calculated every minute of every day. The index measures the relative value of the dollar against the basket. Right now, the index stands at 99, or 1 percent less than its inception. As a guide, the all-time high for the dollar was 164.72 in the Reagan year of 1985 and the low was 70.32 in the last year of Bush 43, which explains a lot.
So why is a dollar index that’s worth less relatively than it was when it was initiated 43 years ago deemed to be so strong? Well, everybody else is weaker with the global economy teetering. It’s been a while for dollar strength; the last bull market was in 2002. But it has appreciated 15 percent in the last year and this can continue. Money is flowing into the U.S. from all over the world and that makes the dollar stronger still.
The biggest positive effect for you is the imports we all love to purchase are much cheaper. Foreign companies manufacture goods in their currency, that is they do things like buy raw materials and pay for labor in a weaker currency and then they send those goods and services here, undercutting U.S. producers, and they get paid in strong dollars. Then they take those dollars home and convert them back to their currency and make a lot of money on the exchange.
On the other hand, U.S. manufacturers have to produce their goods in strong dollars and they have to send those products abroad and they get paid in a weaker currency. So when they bring back the weaker currency and convert it to dollars, they lose a lot of money on the exchange. U.S. exporting companies lost 12 percent last year and that’s important because 46 percent of S&P 500 companies profits come from exports and if they’re losing money, they’re cutting jobs and outsourcing.
In fact, U.S. companies are taking advantage by setting up factories outside the country and that allows them to convert their strong dollars to a weaker currency and purchase base materials and hire cheap labor. They can then sell their products back in the U.S. for strong dollars and do the process all over again. Essentially, U.S. companies are becoming exporters to the U.S. to the detriment of U.S. workers.
The effects of a strong dollar are really a complex matter and our best analysts do not agree on what it all means. I think it’s a net positive because import prices are low and return on investment will be decidedly higher as Assets in U.S Dollars will throw off higher returns for 2017.
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