There is probably nothing as widely quoted and least understood as the value of the dollar. It is sort of like your cell phone. Even children and grandparents have cell phones but most of us think there is a little Genie inside the plastic cover that makes calls by plugging little wires into large circuit boards.
Those of you who are not on a JD binge might have noticed that the value of the dollar has being soaring like Al Roker on Adderall. So let’s step back and try to understand what all that means.
The value of the dollar means nothing until we say – relative to what. A dollar has value as something beyond wall paper when you can trade it for something. You could trade your dollar for a Bo Jackson baseball card. $202 will buy one of those on the Internet right now. Or you could use your dollars to buy gold. An ounce will set you back about $1100 recently. You often use your dollars to buy JD, bread, toilet paper and other essentials of life. That cost is indexed by the Consumer Price Index whose value is 235.
Whenever the cost of the CPI, gold, or baseball cards rises - it takes more dollars to buy one of those things. Alternatively, a single dollar buys less – or it has less value. Main point – the value of the dollar rests in its potential to buy things. When prices increase the value of the dollar falls – when prices decrease the value of the dollar rises. With oil and other prices falling in the US – you could say the value of the dollar has been rising relative to many goods and services.
But there is more to this mystery. Another and equally frequent comparison is how the dollar trades for another foreign currency. We all know that most countries have a currency. We have the dollar but other countries use pulas, pesos, yens, wons, euros and so on. We can track how many dollars trade for these and other currencies.
Recently a dollar could buy 121 yen. A year ago it could buy only 103. Thus we say the dollar increased in value over the past year because it now buys 18 more yen. That’s an appreciation of the dollar relative to the yen of 17%. The dollar rose in value against the euro by more than 20% in the past year.
A 20% change in the value of the currency if continued could cause major changes in the economic environment. When the dollar is stronger…
It buys more euros and yens
Thus if prices in Europe are quoted in euros and in Japanese prices are in yen and those prices remain unchanged, then a rising dollar is able to buy more European and Japanese goods.
Likewise, Euros and yens can buy fewer dollars and so that means that Europeans and Japanese citizens find US goods and services more expensive.
A 20% increase in the value of the dollar (decrease in the value of other currencies) thus tilts the incentives for buyers around the world. The tilt of a stronger dollar is to buy more of the cheaper goods in other countries and fewer of the more expensive US goods.
The above is the main reason why US policymakers face several dilemmas. US firms and labor unions will complain that the strong dollar is hurting their foreign sales. If this trend keeps up you can bet that more will be known about how US firms are losing competitiveness against global companies. Some will worry that all this will be enough to slow overall national economic growth. Thus policymakers will have to pay attention.
The value of the dollar – like any value – cuts in many directions. When the price of eggs rise, consumer hate it but you have to admit that egg sellers love it. A more powerful dollar means that US consumers, including companies, will be paying less for goods they import from other countries. So if you are used to buying electronics or clothing from abroad, it is likely that the prices of these items will be reduced. Companies that buy materials and equipment from abroad will also pay lower dollar prices. They will enjoy the ability to either expand sales at lower prices or increase profits. Like the price of eggs example – the rise in the value of the dollar helps some folks while it creates challenges for others.
Speaking of challenges it is important to keep in mind that US exporters do have options. The price a foreigner pays for US produced goods is also determined by the local price in dollars. So US firms harmed by a rising value of the dollar can recapture foreign customers by lowering the domestic price. This could harm revenue and profits but it does minimize the loss of global competitiveness.
I see it is nearing time for my JD break though there is much more to this story. So let me try to condense it. The rising value of the dollar is mostly the result of a redirection of world demand toward US assets. When the globe buys more US bonds, stocks, and bank accounts, this increases the demand for the dollar and its value. This geographical tilt in purchases of assets is caused by two key factors: monetary policy and economic growth. World investors are pretty sure that two things are happening and will continue to happen for a while. First, central banks in the EU, China, and Japan are determined to lower interest rates in those places – while the US Fed is recognizing that rates will have to rise in the USA. Second, the rest of the world is struggling with economic growth as the US economy improves.
The point of all this is that the value of the dollar is not going to reverse its upward trajectory any time soon because asset return opportunities favor the US. So we better get used to a rising dollar. One of my equally elderly colleagues told me at lunch this week over a lovely bowl of prunes that he could easily see dollar parity with the Euro in the near term – meaning the dollar may rise even more before it stabilizes.