Have you ever wondered how the U.S. dollar impacts various markets? To answer that question, we need to look at the Federal Open Market Committee (FOMC). A branch of the Federal Reserve Board, this committee of five sets the direction of monetary policy.
When the U.S. dollar is strong, imports cost less. This puts pressure on domestic companies because their products are competing with cheaper imports. In this scenario, U.S. companies can’t raise prices and become less profitable.
In contrast, a weak dollar does the opposite. This partially explains why the July 2017 trade deficit narrowed 11.6% from the previous month. This is good news for U.S. multinational companies who sell more products both abroad and at home. This is due, in part, to the valuation on the dollar versus the Euro.
Now here is the part that is perhaps a bit counterintuitive: a declining U.S. dollar on international markets can lead to inflation at home. A weaker dollar means it purchases less today than yesterday. Think of buying a new car in 1987 for $14,000 that costs over $40,000 today. This is the “inflationary effect” the FOMC wants. It also explains why they’ve embraced a softening, not a collapsing, U.S. dollar strategy. The U.S. dollar reached its high for 2017 during the first week of January and has retreated significantly since.
Now that we understand how the U.S. dollar impacts various markets, the positive effect of this move on earnings in the U.S. makes sense. It’s easier to understand how domestic companies improved their bottom line during the past quarter. The U.S. has traditionally lead the way on raising interest rates.
This led to the strong dollar as hordes of fixed-income investors sent dollars to our shores in pursuit of our relatively “high” rates. Today, we are no longer alone; many foreign governments have stopped lowering interest rates, with some even slowly ratcheting rates higher. In January, the 10-year German bond was negative by more than a half-point; today, it is almost 0.4%. This is a huge move.
Impact on Commodities
Commodities that trade in U.S. dollars typically go up when the U.S. dollar goes down. When foreign buyers purchase commodities traded in U.S. dollars, the relationship is inverse. A weaker U.S. dollar gives foreign currency more buying power and it purchases more dollar-based commodities.
It is this relationship that makes gold and platinum such strong indicators of inflation and dollar movement. When gold and platinum rally at the same time, it’s typically the result of a weaker U.S. dollar. Both commodities cost more in dollar terms to purchase. When gold rallies on its own, it’s acting like a currency and doesn’t necessarily signal a deflating U.S. dollar.
We never wish for war or threats of armed conflict involving the U.S. However, from a purely economic standpoint, military actions tend to be good for the economy. A conflict would most likely push us out of the low-inflation, low-growth environment we’ve become accustomed to. The basic premise is that during wars, factories increase production, and employment explodes. Resources are used, and the economy hums along. Considered a safe currency, the U.S. dollar appreciates during unstable times. Gold also rises because it acts as a safe currency, something we have seen most recently during the heightened tensions between North Korea and the U.S. Government.
While not absolute, you can see how currency prices affect our overall economy. We need to pay attention to the relationship of high dollar or low dollar and the relative value of companies.