Walk into any grocery store and it’s only too obvious that a dollar won’t buy much of anything, not even a quart of milk.
Inflation has done that. The latest government figures showed that in August, even a fistful of dollars bought 11.4 percent less food, 25.6 percent less gasoline and 6.2 percent less housing than they did a year earlier.
Any American consumer knows very well that a dollar doesn’t have the swagger it once did in the United States. Yet in financial circles, it is frequently said that the dollar is strong. I’ve written this in previous columns, and the claim is repeated constantly in headlines and speeches.
But what do we mean when we say the dollar is strong?
Recognize, first, that the phrase isn’t neutral. Given a choice between strong and weak, who wants to be weak? When it’s said the dollar is strong — and traditional U.S. government policy says the dollar should always be strong — that sounds unambiguously positive, with a precise meaning.
But the strong dollar is neither of those.
Paul O’Neill, Treasury secretary under President George W. Bush in 2001 and 2002, was forthright about this, after he left office. “I was not supposed to say anything but ‘strong dollar, strong dollar,’” he said. “I argued then and would argue now that the idea of a strong-dollar policy is a vacuous notion.”
Really, there are at least three meanings when we say, “The dollar is strong.” None is entirely good for American consumers or investors.
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First, and most straightforward, the dollar buys more yen, pounds, euros and renminbi than it has in decades. It can be exchanged for more foreign currency.
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Second, the dollar anchors international finance and commerce, a role once played by the British pound.
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Third, the dollar is a weapon, one that the United States is using against adversaries like Russia and Iran.
In all three ways, the dollar is playing an extraordinarily important role, not just in the United States but almost everywhere on the planet.
If you are a consumer, an investor or just a person who wants to live peacefully and prosperously, the strong dollar is a mixed blessing, at best.
Purchasing Power
In the basic definition of dollar strength — its worth in other currencies — this has been the dollar’s best year in decades. The U.S. Dollar Index, which tracks the dollar’s value against six major currencies, was up 16.9 percent this year through Thursday, and hovering around its highest levels in 20 years. In direct matchups with the British pound, the euro, the Japanese yen and the Chinese renminbi, the dollar is, likewise, higher than it has been in years.
This buys you better meals and drinks if you are an American traveling abroad, but it is a hindrance if you are investing in the stock of American multinational companies. Those with the most international exposure are being severely penalized in this bear market.
Consider two subindexes of the S&P 500. The S&P 500 U.S. Revenue Exposure Index, filled with domestic-oriented companies like Berkshire Hathaway, UnitedHealth Group, Home Depot and JPMorgan Chase — dropped 12.7 percent this year through Thursday. That’s not good, but it’s far better than the 24.8 percent loss of the S&P 500 Foreign Revenue Exposure Index, which includes Apple, Microsoft, Alphabet and Tesla, big drivers of stock market returns. On balance, the strong dollar has probably been a drag on investment, even within the United States.
For the economy, in the United States and around the world, the strong dollar has caused pain in many ways, too. A Sept. 29 analysis by Morgan Stanley summarized the effects of the dollar’s appreciation this way: “It takes a toll on economic growth, in particular through depressing the demand for U.S. exports and increasing the attractiveness of foreign goods and services.”
On the plus side, the strong dollar reduces the price of foreign goods in the United States. Inflation here would be worse without it.
So dollar appreciation coincides with the current policy of the Federal Reserve, which is focused on bringing inflation down.
That’s not always been the case. In 2014 and 2015, Federal Reserve officials said they would not raise interest rates precisely because the dollar’s appreciation then was weakening the American economy. And in 2018, during the Trump administration, Treasury Secretary Steven Mnuchin pointed out that a weaker dollar would help U.S. companies compete — only to be chided by Larry Summers, the former Treasury Secretary, who said the U.S. government “should stick with the strong dollar mantra,” come what may, to protect the Treasury’s “credibility.”
At the moment, Morgan Stanley estimates, current dollar appreciation is adding to the effects of interest rate increases in the United States. The dollar’s rise is roughly equivalent to an increase of about 0.40 percentage points — on top of the 3 percent increases in the federal funds rate already imposed this year by Federal Reserve policymakers. In other words, the appreciating dollar is slowing the rate of inflation in the United States — but increasing it in much of the rest of the world — and doing all of this by weakening the economy both in the United States and around the world.
John Lynch, chief investment officer at Comerica Wealth Management, put the conundrum this way: “Dollar strength equates to global currency weakness, fanning inflationary pressures around the world. Consequently, central banks in developed and emerging economies are confronted with the conflicting necessity to raise interest rates to fight inflation and support their currencies, despite weakening economic growth.”
As New York Times colleagues in Asia have pointed out, a rising dollar and a disorderly decline in the value of other currencies caused a global debt crisis 25 years ago, requiring international bailouts. If the dollar keeps rising now, it could disrupt economies in unforeseen ways.
The Heart of Finance
The dollar is the fulcrum of the world’s trading and financial system, a position that it has occupied, with periodic adjustments, since it supplanted the British pound during World War II.
The strongman role of the U.S. currency and the weakness of the British one were on spectacular display this month, when the new British government was compelled to reverse its fiscal policy in response to the cratering of its currency. It abandoned plans to cut taxes for wealthy people largely because the prospect of widening British deficits caused a run on the pound.
Thanks to the central role of the dollar, the U.S. government has been largely immune from such financial pressures when its habitual deficit spending has seemed imprudent to outsiders. In a world crisis — even one emanating from the United States, such as the periodic brinkmanship in Congress over the raising of the U.S. debt ceiling — investors tend to pour their money into the safest assets. Remarkably, even when the United States is causing disruptions, the haven of choice is, for the most part, dollar-denominated Treasuries.
A Formidable Weapon
The dollar’s primacy has always added to American geopolitical power. Now, the dollar is being increasingly used as a weapon against American adversaries.
Most foreign exchange reserves are held in dollars, and more global trade is transacted using dollars than any other currency. That’s given the United States the ability to freeze dollar assets as leverage against other nations, and it has done that through the decades against Cuba, North Korea, Afghanistan, Iran and Venezuela.
But with Russia’s invasion of Ukraine, the United States and its allies sharply escalated the “weaponization of global finance,” according to a recent State Street study, freezing nearly half of the Russian Central Bank’s estimated $630 billion in foreign exchange and gold reserves. The allies have also frozen the assets of individuals and Russian banks, and severely limited Russia’s access to the international payment system, known as SWIFT. Such sanctions are now a standard part of the policymaking playbook, for reasons that have far more to do with political and military power than traditional finance.
The Goldilocks Dollar
Forecasts of the end of the dollar’s role in international finance have been rampant — and wrong — since 1971, when President Richard M. Nixon took the dollar off the gold standard, leading the world toward the floating exchange rate system that we now take for granted.
A new backlash against the dollar is developing, and a range of countries, from Russia to China and Saudi Arabia, have been working on alternatives in international finance. Some cryptocurrencies have been promoted as dollar substitutes.
I won’t hazard a prediction, except for these observations.
First, the current high dollar exchange value will surely reverse itself, as it has before, once the Federal Reserve pivots and worries more about economic fragility than inflation. Second, the dollar is slowly losing ground in international finance but until there’s a better option, predictions of its demise will continue to be premature. Third, the weaponization of the dollar is likely to hasten its decline because no country wants a financial system in which it can easily lose access to its own money.
Really, we will all be much better off if we don’t have to think so frequently about the dollar — about its puny purchasing power at home, its exorbitant exchange rate or its use as a potent weapon.
A strong dollar isn’t a sustainable goal. A Goldilocks dollar, one that isn’t overwhelming the world or underwhelming consumers, is.
