Currencies

Why is the value of the US dollar so strong right now?


The value of the US dollar against other major currencies has reached its highest level since the early 2000s. Even as recession fears mount and the economy shows signs of slowing, the dollar continues to surge.

The dollar, which has been on a steep upward climb for about a year now, equaled the value of the euro this month for the first time in two decades. The Japanese yen has also fallen sharply against the dollar.

A strong dollar can make products imported into America cheaper and make trips abroad less expensive for American travelers. Big companies that operate in multiple countries, such as Johnson & Johnson, have recently complained that the rising dollar could hurt their profits since foreign sales lose value when converted back into dollars and they become less competitive with local companies as their products become more expensive overseas.

Economic policymakers and Biden administration officials have claimed the strong dollar could even help bring down inflation in the United States, which has been running at its fastest pace in four decades. Economists say the impact would be relatively small, but still positive, given that many households are struggling to afford essentials like food, rent, and gas.

A strong dollar also has broad implications for the global economy, devaluing currencies in other countries. The value of the dollar also matters a lot for emerging economies, since it puts those countries at a greater risk of defaulting on their debts.

Here are answers to four key questions you might have about the strength of the dollar.

1) Why is the dollar extremely strong right now?

The basic explanation for the strong dollar boils down to this: While things might be weird in the US economy right now, a combination of factors has made the dollar a better bet for investors than most other currencies.

The dollar has been rising in large part because the Federal Reserve is on track to increase interest rates faster than other major countries, said Kenneth Rogoff, an economics professor at Harvard University and a former chief economist at the International Monetary Fund.

The central bank started to lift interest rates in March after keeping them at near zero for much of the pandemic, and carried out another big rate increase on Wednesday, raising rates three-quarters of a percentage point. Higher interest rates make the dollar more attractive to investors, since it means they would get a bigger return.

Russia’s invasion of Ukraine has also strained European economies and made natural gas prices skyrocket, making the US economy look healthier in comparison, Rogoff said.

“Everyone’s talking about a recession, but the US economy is doing better than a lot of other economies,” he said.

The dollar is acting as a “safe haven,” said Vassili Serebriakov, a foreign exchange strategist at UBS, an investment bank. As the growth outlook for the world economy worsens, investors have grown more concerned and flocked to the dollar, putting their money into safer assets like US Treasury bonds, Serebriakov said. That in turn has pushed up the currency’s value.

“More recently, it has less to do with the US and more to do with a global downturn,” Serebriakov said.

2) What does this mean for Americans?

Among other things, a stronger dollar helps curb inflation by making imports cheaper, said Marc Chandler, the chief market strategist at Bannockburn Global Forex, a trading firm. Foreign sellers are more inclined to drop prices when the dollar becomes more valuable, translating to lower prices for imported products that Americans buy.

But with prices running as high as they are now, that may not provide much relief to consumers. Chandler said the strength of the dollar could shave off 0.2 or 0.3 percent off overall inflation, a small amount compared to the 9.1 percent increase in consumer prices from a year ago.

“Wages are not keeping pace with inflation,” Chandler said. “And so does a stronger dollar really do that much for it? Probably not.”

There are other bright spots. It’s commonly known that a stronger dollar is good for American travelers, who can get more for their money in other countries. Americans are already finding it easier to fund European vacations and purchase luxury goods and fine wines in other countries. Some American buyers are even househunting in countries like France, since the weaker euro means it’s cheaper for them to buy real estate in Europe compared to a year ago.

Although a strong dollar is mostly favorable for American consumers, it can have more negative impacts on companies that operate businesses in other countries because revenue and profits earned in local currencies are worth less in dollar terms and their products become more expensive abroad, reducing demand.

Exports also become more expensive abroad, which could hurt American companies that export goods or services. Workers in industries like agriculture or manufacturing could also be impacted if their jobs depend on exports.

Overall, though, many Americans might not notice the effects of a stronger dollar in their daily lives, said David Wessel, the director of the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy. Compared to many European countries, the United States is more self-sufficient, producing much of what Americans consume, Wessel said.

Wessel noted that a stronger dollar can make real estate in the United States more expensive for foreign buyers, making those investments less attractive to them. That could help relieve some price pressures in the housing market, a positive outcome for Americans trying to buy homes, he said. But generally, people in other countries are more likely to feel the impact of a stronger dollar than Americans.

“If you go to some other countries, people are fixated on the exchange rate,” Wessel said. “Whereas my guess is, most Americans don’t have any idea whether the dollar is strong or weak.”

3) What does this mean for other countries?

For other countries, a strong dollar pushes import prices up, which can create inflation in those regions. The impact can also be brutal for emerging economies.

When US interest rates are low, global investors tend to invest more in emerging markets, or the economies of nations that are transitioning into developed economies. But when rates start to rise in the United States and the dollar climbs, money starts to flow out of those countries, Wessel said.

Some developing nations are better equipped to handle this, since they have more reserves or their exports are priced in dollars and have been rising in value, but other countries could struggle. Sri Lanka’s economy, for example, is starting to crumble as it deals with a mountain of debt and not enough US dollars to pay for imports of essential goods.

Countries that borrow heavily in dollars could suffer because it becomes harder to make repayments as the dollar rises and their currencies depreciate, said Mark Sobel, the U.S. chair of the Official Monetary and Financial Institutions Forum and a former top Treasury Department official.

“That means the amount of dollars they need to get their hands on to make repayments goes up,” Sobel said.

4) Where does the dollar go from here?

Currency markets are extremely hard to predict, so it’s difficult to say whether the dollar will continue to climb or fall in the coming months. Rogoff, the Harvard economics professor, said the dollar could drop if the war in Ukraine “miraculously” ceased, relieving pressure on European economies and pushing up their currencies.

The dollar could also fall if the US enters a recession and the Fed has to cut interest rates to stimulate the economy, which some analysts predict could happen next year. An economic downturn in the United States could also make investing in US assets and companies look less attractive, which could result in the dollar falling, Rogoff said.

On the other hand, if inflation stays stubbornly high and the Fed has to keep raising interest rates more than expected, the dollar could keep rising. It could also climb if the European Central Bank, which raised interest rates for the first time in more than a decade last week, has to backpedal and cut rates, Rogoff said.

“It’s a very uncertain environment, and the exchange rate probably is going to be hard to predict,” Rogoff said.



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