During the past several months, the weaker value of the U.S. dollar has been headline news. But if you keep track of headlines, you might also recall that about five years ago, there was a considerable outcry about the dollar’s unprecedented strength.
So which is preferable, a strong dollar or a weak one? Actually, there are benefits to both sides of a fluctuating currency. What matters most is how you react to changing conditions.
Isn’t a Dollar Just a Dollar?
If the dollar were the world’s lone currency, there would be no such thing as dollar weakness or strength. Here at home, the dollar serves primarily as a unit of account and a store of value. In dollar-denominated transactions, the dollar’s purchasing power is a matter of agreement between spenders and sellers.
However, when two parties using different currencies want to transact business, the exchange rate between the two currencies may affect the price of the transaction.
The Strengths of Weakness
A weak dollar isn’t necessarily bad news for the stock market or the economy. U.S. manufacturers tend to applaud a weaker dollar because it makes U.S. made products more competitive in foreign markets and increases foreign consumer purchasing power. A weak dollar may also drive up import prices, which can benefit U.S. manufacturers because their goods and materials become more attractive to domestic consumers.
On the other hand, a weakening dollar may attract fewer foreign investors to U.S. financial markets. For decades, the world has valued the dollar as a reliable store of value because our stable financial, legal, and banking systems have helped minimize the kinds of risks that routinely threaten currency values in less stable economies. This was especially visible in the late 1990s, when foreign investors from around the world poured their capital into dollars in pursuit of the unmatched opportunities in our financial markets. The spike in demand drove the dollar's value to unprecedented highs compared with the currencies of a large group of major U.S. trading partners.1
Of course, there are many other risks associated with currency fluctuations, but risks also tend to accompany opportunities. It’s important to be aware of changes in the value of a dollar, but it’s even more important to keep them in perspective.
1) Federal Reserve, 2007
©2008 Emerald Publications