Throughout coverage of the recession, news commentators have focused on how the dollar is weak or how there are signs the dollar is stronger than we think. Consistently, this discussion is had around the fundamental strength of the dollar; but what does this actually mean, and why should any of us care?
What Is A Strong or Weak Dollar?
The performance of the United States dollar is compared to the performance of other foreign currencies. A strong dollar means it is retaining its value compared to other currencies, and a weak dollar means that it is losing value compared to other currencies.
Put another way, a strong dollar is able to buy more goods and services from the countries to which it is being compared. It can be expressed in terms of conversions, such as “1/1.75 USD/CAD,” which indicates that 1 US dollar can purchase 1.75 Canadian dollars.
Why Does the Dollar’s Relative Strength Matter?
Of course, there is no one single parameter or variable that anyone should focus on. However, the dollar’s relative strength can tell a lot about overall economic trends while also offering some perspective on consumer sentiments. It focuses on the holistic global economy, whereas many other commonly-tracked economic parameters focus almost exclusively on domestic.
Throughout the rest of this article, you can pretty much always assume that the inverse is true as well (unless otherwise specified). So, for all of the effects we describe below for the strong dollar—which we focus on because people are always surprised to hear that strength does not always lead to favorable circumstances all of the time—the opposite could also unfold with a weak dollar.
A Strong Dollar: (Potentially) Too Much of a Good Thing?
In the Canadian dollar example given above, the US dollar is strong: just $1 can purchase almost two Canadian dollars. The more CAD that can be bought with one American dollar, the stronger the American dollar is, and vice versa. This is a great and desirable set of circumstances, isn’t it?
Not so fast. While we do want the dollar to be strong, there are some important considerations to keep in in mind here. At the end of the day, they all hinge upon the premise that nothing in economics is forever.
A strong US dollar, as already noted, shows that the exchange rate is in our favor, and therefore gives us more value when shopping for good elsewhere. This includes any goods that are imported, and can be purchased for less using the power of a strong dollar.
But while this strength is a great status to attain, it won’t last forever — and that could arguably be a good thing, given the domestic economic circumstances that would persist if it did. The strength of the dollar also means that American goods are more expensive for other countries to buy, which in turn can reduce our volume of exports.
Over time, American companies will want to reduce costs in response to this trend. They will likely pivot to building facilities and hiring employees overseas, where it costs less to do business. The domestic workforce will gradually start to lose jobs in the sectors implicated by this overseas move. If the need for cutting back company costs continues over time, this can have more serious ramifications on the American economy.
Again, a simple read on the relative strength of the dollar could shed the insights noted above. This is why it persists as a reported metric, and why keeping an eye on it can help you understand emerging economic trends.