dollar strength is unusual

Over my working career, the US government has maintained a policy of encouraging gentle US dollar weakness, while keeping up a rhetoric (for domestic consumption) of wanting dollar strength.

From a practical point of view, what’s important for investors is that the current situation of considerable actual dollar strength is unusual.

$ ↑ means S&P earnings ↓

I’ve already written about the negative effects of the greenback’s strength against the euro on reported earnings for the S&P 500.  The EU currency has lost about a quarter of its value against the dollar over the past nine months or so.  Put another way, the 25% of S&P profits derived from the EU are worth 25% less in dollars than a year ago.  In back-of-the-envelope terms, this means overall S&P profits are now running about 6% lower than  they would be were the exchange rate back at €1 = US$1.38.

effects in weak currancy countries

Today’s post is a look at the other side of the coin–the effects of the dollar rise on sales of dollar-denominated products.

These fall into two classes:

—products made in the US.  Here the situation is easy to understand.  The higher local currency price of US products decreases demand for them in weak currency areas like the EU, and increases demand for locally produced substitutes.

—global commodities, which–from metals to energy to agricultural products–are priced in dollars in international trade.

commodities

the first round

For a producer in a weak currency country, the dollar rise initially means a jump in local currency profits.

For a weak currency consumer, the dollar increase means an immediate rise in local currency costs.

responses

The consumer responds to higher prices either by:

–consuming less, finding substitutes (like an extra blanket, or switching from coffee to tea, or riding the bus instead of driving) or

–cutting back on other things.

The producer waits to see the consumer response.  If there’s a dramatic falloff in demand, he can counter this by lowering prices.

the net effect…

…is a loss of purchasing power for the weak currency earner–and a consequent weakening of overall GDP growth.  The main question is how well substitution can cushion the blow.

a saving grace…

The collapse in the oil price, which began at about the same time as the dollar rise, has offset much of the currency damage to GDP in oil consuming countries.

…for most

The currency gains that oil producing countries may have made from lower  costs have been far outweighed by the plunge in unit revenues they’ve suffered.

the bottom line

The US is not a particularly export oriented country. And it’s a large net oil importer.

For most, the rise in the dollar has had  no negative effects–plus the mild positive of lower cost of  imported goods.

On the other hand, for citizens of, say, Japan, which imports large amounts of food and fuel, the fall of the dollar has been a disaster for ordinary consumers–mitigated only by the plunge in the oil price.  Europe is somewhere in the middle, consumers squeezed by a rise in the cost of commodities but buoyed by the large decline in the price of imported oil and gas.