Well as you’ve probably seen the U.S. dollars has been strengthening in relation to many
other currencies.
On the surface this certainly sounds positive, and to be honest there are quite a few positives.
But there are also some areas that aren’t positively affecting by a strong dollar.
Now in order to understand this, we need to understand how exchange rates work.
An exchange rate is simply the value of one nation’s currency in comparison to that
of another.
For example, 1 U.S. Dollars can be exchanged for .86 Euros.
So if we were traveling to Europe and want some spending money 100 U.S. Dollars would
get you 86 Euros.
Generally speaking currencies fluctuate based upon the demand for a nation’s currency
as well as goods produced in that currency, but they also fluctuate based upon supply.
Meaning that if a country engages in some type of accommodative monetary policy there
is likely to be an impact upon the value of their currency.
For the most part, nation’s utilize what’s called a floating exchange rate.
This means that the value of their currency fluctuates depending upon market conditions.
Lets talk about the impact of a strong U.S. dollar, much like we’re experiencing currently.
When a currency strengthens that means it can be exchanged for more of another currency.
For example, in January of 2014 one U.S. dollar could be exchanged for about .73 Euros.
But because of an improving U.S. economy and economic troubles in Europe, the U.S. dollars
has strengthened.
So now one U.S. dollar is worth about .86 Euros.
This strengthen of the dollar has number of different implications.
First lets look at some of the positives.
As an American citizen traveling to Europe you would likely be pleased with a strong
dollar.
To illustrate this let we walk through a brief scenario.
Lets say you wanted to travel to Europe about a year ago and you obviously wanted to convert
some dollars into Euros.
Last year, if you exchanged 500 U.S. dollars into Euros you would be left with about 350
Euros.
You might be thinking “Well that doesn’t sound too bad.”.
But lets see what happens now that dollar has strengthened against the Euro.
If you were to take that same 500 U.S. dollars and exchange it Euros today, you would receive
430 Euros.
Essentially you receive an additional 80 Euros just because of the exchange rate.
Not a bad deal.
So businesses in Europe that cater to tourists such as hotels, restaurants, and other services
may actually benefit from a stronger dollar and subsequently a weaker Euro.
Outside of tourism, where else do exchange rates have an impact?
Lets look at imports and exports.
Just to refresh, an import constitutes goods that are produced in another country and brought
into the country for consumption.
So automobiles manufactured in Japan and shipped to the U.S. for sale would be considered imports
from the perspective of the U.S. An export is the exact opposite.
In this case a good to produced domestically and shipped internationally for consumption.
You’ve probably noticed that fuel prices in the U.S. have declined significantly over
the past six months.
This is in part due to the U.S. exporting more oil, which results in a greater supply
of oil on the market.
Based upon your knowledge of exchange rates thus far, would you say that U.S. exports
benefit from or are hurt by a strong dollar?
Lets walk through a quick example.
Suppose our firm sells products for 50 U.S. dollars.
Under the old exchange rate, this product would sell for 36.5 Euros.
But with a stronger dollar, that same product now sells for 43 Euros.
Meaning that the identical product now is 17 percent more expensive simple due to the
exchange rate and not a price increase by the firm.
This can result in decreased demand for these types of products, which can negatively affect
the sales of U.S. export businesses.
The important thing to remember is that there are winners and losers when a dollar strengthens
in value.
Although U.S. importers enjoy a stronger dollar as it means they can purchase more foreign
made goods with the same amount of money, U.S. exporters tend to prefer a weaker dollar
as it makes their goods appear more attractive to other countries.