The U.S. dollar spent August surging against Asian currencies. Behrouz Mehri/AFP via Getty Images
Ever since the Federal Reserve started raising interest rates to beat back inflation, the U.S. dollar has been on something of a tear. So much so that last summer, some big corporations complained that the greenback’s strength was eating into their overseas profits. More recently, there have been signs that the dollar’s strength is moderating.
But currency markets can be volatile, and the dollar spent the month of August surging against Asian currencies in particular; Bloomberg’s Asia Dollar Index just fell to its lowest in 10 months. The Chinese yuan fell to its lowest since 2007. All of that prompted strong words from authorities in Japan and China —both countries said they’d take steps to stem their currencies’ slide.
If you’re outside the U.S., there is basically one upside to a strong dollar: U.S. consumers and companies have money that goes farther, so they can buy more of what you’re selling, noted Gian Maria Milesi-Ferretti of the Brookings Institution.
“In dollar terms, your cost of production is going down, and hence you can —if you want —sell more, given that you are more competitive,” he said.
Beyond that, a strong dollar is mostly downside. Start with the fact that many governments and companies borrow in U.S. dollars.
“The value of the debt in terms of their domestic currencies has gone up, the debt servicing costs have gone up,” said Eswar Prasad, a professor of economics at Cornell University. “And usually, when the dollar strengthens, it makes it much harder to get new loans in dollar terms.”
Also, a stronger dollar makes it harder for countries to keep investments local. Rising interest rates have made parking money in the United States particularly attractive.
“You could borrow money at nearly 0% in Japan and invest it in either short-term CDs or buy treasury bills and earn a significant, positive yield,” noted Vassili Serebriakov, a foreign exchange strategist at UBS.
There are a couple of tools central banks can use to keep their currencies from depreciating against the dollar.
For one, they can raise their own interest rates, even if their own economies aren’t running so hot. Brookings’ Milesi-Ferretti said that this is known as “defending the currency.”
“It is not a defense that is cost-free,” he said, “because higher interest rates will take a toll on the domestic economy, as they do in the U.S.”
Another tool is what’s called direct intervention in foreign exchange markets. Countries save up reserves of dollars precisely for this reason, said Cornell’s Prasad. “Rainy day funds —those are exactly what those are.”
So when the sky’s getting cloudy, a central bank can sell U.S. dollars, buy more of its own currency and hopefully keep it from falling too far.
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FAQs
It reinforces America's economic dominance and it helps reduce inflation by making imports cheaper. But a rising dollar doesn't lift all boats. Some exporters have been hit as the stronger domestic currency makes them less competitive in overseas markets, while also creating economic headaches around the world.
What is the problem with a strong dollar? ›
A strengthening U.S. currency intensifies inflation abroad, as countries need to swap more of their own currencies for the same amount of dollar-denominated goods, which include imports from the United States as well as globally traded commodities, like oil, often priced in dollars.
How does the US dollar affect the economy? ›
A weak U.S. dollar allows your export business to remain competitive in international markets. Conversely, a stronger currency can reduce export competitiveness and make imports cheaper, which can cause the trade deficit to widen further, eventually weakening the currency in a self-adjusting mechanism.
What are the benefits and possible disadvantages of a country in the US dollar as its currency? ›
For dollarizing countries, advantages include lower administrative costs, a firm basis for a sounder financial sector, and lower interest rates. Disadvantages include the loss of monetary autonomy, seigniorage, and a vital national symbol as well as greater vulnerability to foreign influence.
What are the negative effects of a strong dollar? ›
“And usually, when the dollar strengthens, it makes it much harder to get new loans in dollar terms.” Also, a stronger dollar makes it harder for countries to keep investments local. Rising interest rates have made parking money in the United States particularly attractive.
Who would not benefit from a stronger U.S. dollar? ›
For example, a strong dollar benefits Americans traveling overseas because $1 buys more; however, this would disadvantage foreign tourists visiting the U.S. because their currency would buy less.
Why is a strong dollar bad for emerging markets? ›
A strong U.S. dollar generally harms the economies of emerging nations. Emerging markets are reliant on foreign investment and foreign capital, both of which can evaporate when the dollar gains in value.
What currency is worth the most? ›
The Kuwaiti Dinar (KWD), recognized as the highest-valued currency globally, symbolizes Kuwait's economic strength.
Who benefits from a weak dollar? ›
A weaker dollar, however, can be good for exporters, making their products relatively less expensive for buyers abroad. Investors can also try to profit from a falling dollar by owning foreign-currency ETFs or investing in U.S. exporting companies.
What is the importance of the U.S. dollar in the world economy? ›
The USD remains the world's reserve currency, providing relative stability and safety compared to other currencies. The dollar also supports global trade through its role in banking and its ease of use. The large supply of U.S. Treasuries also helps to preserve the USD's dominant role.
A falling dollar diminishes its purchasing power internationally, and that eventually translates to the consumer level. For example, a weak dollar increases the cost to import oil, causing oil prices to rise. This means a dollar buys less gas and that pinches many consumers.
How many countries accept the U.S. dollar? ›
USD is used within the United States and its official territories (Puerto Rico, Guam, America Samoa, U.S. Virgin Islands, and Northern Marina Islands). There are also eleven other countries which use the USD as their official currency.
What does a weak dollar mean for the economy? ›
A weaker dollar can lead to higher import prices, as it becomes more expensive to purchase foreign goods and services. This can contribute to inflationary pressures in the economy, potentially affecting consumer purchasing power.
Does the dollar get stronger or weaker in a recession? ›
When both the US and global peers are in recession, the US dollar experiences a reversal of fortunes. One explanation is that during a global risk-off environment, investors will flock to the US dollar as a perceived safe-haven asset, and the demand drives up the value of the dollar.
Does high inflation strengthen or weaken the dollar? ›
With inflation rates climbing, the value of currency diminishes, meaning $100 today might not buy as much in terms of food, energy, and shelter tomorrow. The US uses two metrics, PCE and CPI, that measure two different baskets of goods to gauge the dollar's purchasing power over time.
What makes the U.S. dollar stronger or weaker? ›
Like any other fiat currency, the dollar's value depends on the economic activity and outlook of the United States. In addition to supply and demand and market factors, sentiment influences the dollar's value on the global market.
