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Why is a Strong U.S. Dollar So Bad for Everything Else?

The currency market (i.e., Foreign Exchange/FOREX) and its participants make up the largest market in the world, encompassing $5.3 trillion dollars per day.

That is a figure that cannot be ignored.

Exchange rates around the world are affected by any number of things, but a few of them are more important than the others.

Interest rates are probably the biggest driver. Central bankers use interest rates to manage their economies and the way they grow. Economies that grow too fast run the risk of inflation and forming bubbles. This means that cash is too cheap to borrow and is being deployed all over the place. That can cause prices to rise as more cash is chasing the same amount of goods. That is the definition of inflation.

When economies begin to expand too quickly, central bankers move to raise rates. This will have the effect of slowing the economy down. That helps to ease inflation and bring prices back down to earth.

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You can see how the currency would react to the moves in interest rates. Rates that are low are encouraging business investment and the deployment of cash because it is so cheap to borrow. People are hired and paid, goods and services are bought, and inflation begins to creep into the system. If other interest rates around the world are higher, U.S. businesses will invest abroad for a better return.

As things begin to heat up and the economy improves, the bankers move to slow things down so the economy doesn't overheat. An overheating economy is just as bad or maybe worse than a stagnant economy. A good example of an economy that is overheating is one with very high inflation. Zimbabwe comes to mind. They are struggling with mind-blowingly high rates of inflation - runaway inflation, for that matter. Way over 50%, when here in the U.S., we are struggling to get 1.5% and on our way to 1%. By raising rates to slow the economy down, you are encouraging foreign investment back to the U.S., slowing down exports, and putting the brakes on the amount of capital in the system. By raising rates, you encourage saving and the slowing down of purchases. This also strengthens the currency as the rate of return on investment goes up with the raising interest rates.

When you are in dire straits as an economy, you lower rates to cheapen your currency to spur on inflation. You hear people talk about 'importing' inflation. That is a way of thinking that believes that inflating your economy will get cash and investment moving and make your goods and services attractive to the rest of the world. The problem now is that when the FED embarked on this policy in the states, the rest of the world was weak as well and could not invest in the U.S. and prop up the economy.  We weren't able to import inflation. Now, as the rest of the world has weakened much more than we have, our economy, though very sluggish, looks great to those abroad. So, by weakening their own currencies (12 countries already this year) they have by default strengthened ours. And, if the FED wants to raise rates for some reason this summer, it will only move to exaggerate the issue.

That is why a strong dollar hurts things denominated in dollars that are being sold overseas. By default, our currency is getting stronger and making our goods more expensive to the rest of the world. This will be the theme for the year and cannot be ignored in your marketing plan.

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