Strong Dollar Blues

The recent weakening of the US dollar has raised concerns about the status of ‘King Dollar’. While the massive debt burden and budget deficits of the US certainly raises eyebrows, it probably does not spell the end of dollar supremacy just yet.

In 1985, the “Plaza Accord” saw G5 countries (U.S., Japan, West Germany, France, and the U.K.) work in coordination to weaken the dollar in an attempt to lessen the U.S. trade deficit. Now, 40 years later, we are in a similar situation, but there are many more trading parties, not the least of which is China. The President’s efforts appear to be designed to force ‘Plaza Accord II’ by pressuring trading partners to strengthen their own currencies or face tariffs and other trade barriers.

The dollar has weakened substantially since President Trump took office, but we need to keep that recent weakness in perspective. The bigger picture is that the strength of the dollar over the last 20 years (see chart above) has raised the cost of US exports, playing a role in our growing trade deficit. This extended rise in the US dollar for the past two decades allows President Trump to encourage policies that would weaken the dollar further. A weaker dollar makes American exports cheaper on global markets, potentially boosting exports and supporting domestic manufacturing, a core goal of this administration.

However, achieving and sustaining a weaker dollar is complex and comes with significant economic risks. A weaker dollar is a two-edged sword. While it makes U.S. exports cheaper, it also makes imports more expensive, raising the specter of rising inflation for American consumers and businesses. Items that are unable to be sourced locally either through existing or new manufacturing capacity can lead to inflationary effects for the consumer. This is a reversal of our experience over the last 24 years when, following China’s entrance into the World Trade Organization, manufacturing migrated to China in search of lower manufacturing costs. In effect, China exported deflation as U.S. prices declined as a result of China’s low cost manufacturing base.

The Investor’s Perspective

Economists will continue to debate the President’s economic plans, but for investors, a weaker dollar brings some opportunities. A weak U.S. dollar generally boosts the profitability of U.S. multinational companies. This occurs for two reasons:

      • Higher Value of Overseas Earnings: When U.S. multinationals earn revenue abroad, those earnings are in foreign currencies. If the dollar weakens, converting those foreign earnings back into dollars results in a higher dollar amount, increasing reported profits.
      • Increased International Demand: A weaker dollar makes U.S. goods and services cheaper for foreign buyers, often driving up demand and sales abroad, further supporting profits.

Tariffs can complicate the overall impact, but the direct effect of a weak dollar is generally positive for U.S. multinationals’ profitability.

A weaker U.S. dollar also makes foreign stocks more attractive to U.S. investors.

      • Currency Translation Gains: When the dollar weakens against local currencies, any investment gains in those currencies are amplified for U.S. investors by the relative strength of the local currency to the dollar.
      • Investment Flows: The dollar’s decline can also encourage international investors to seek returns in stronger currencies and markets, increasing demand for European stocks. International flows to U.S. stocks have been enormous for a very long time. Any reversal of those flows based on a weaker dollar could be very supportive of foreign stock markets.

The US dollar’s rise over the past 20 years is some reflection of our substantive role in the world economy as well as our political and economic growth and stability. It unfortunately can lead to a self-correcting mechanism of making our goods less attractive globally, and a growing trade deficit, just as it did in 1985 leading to the Plaza Accord.

The Trump Administration is seeking to “rebalance” this lopsided US trade deficit again through a weaker dollar and renegotiated trade deals.  We hope their efforts can do so without setting off a US recession or further global economic challenges, but that will not be an easy task.

Have a great week!

What We’re Reading

 

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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

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General News

By: Adam