The Good and Bad of a Strong Greenback

The U.S. dollar broke new records last month, trading above parity with the Euro (symbol: €) for the first time since 2002 and reaching a 20-year high against the Japanese Yen. Backed by the Federal Reserve’s (Fed’s) determination to tame inflation through hiking interest rates, the strong dollar has several consequences – both good and bad.

Pent-up demand and a strong greenback (United States dollar) have resulted in Americans flocking to Europe this summer. It is estimated that European travel will be up 600 percent year-over-year, as goods and services are now significantly cheaper in Europe making a hop over the pond far more affordable.¹ To put this price differential into context, the price arbitrage of luxury goods, such as the prized Chanel flap bag, could just make up for the cost of the flight. Currently, the bag is priced at U.S. $9,500 in the U.S. and €8,400 in Europe. With the Euro and dollar trading at parity, that’s a $1,100 price advantage to buying the purse in Europe and that does not include the 12 percent European Value Added Tax (VAT) refund for tourists.² 

Yet, there are two sides to every coin, and the other side is a less rosy picture.  Tighter monetary conditions at home have significantly increased the cost of U.S. dollar-denominated debt repayments, impacting many emerging economies at a time when food scarcity and sovereign indebtedness are at record highs. Earlier this year, Sri Lanka defaulted on its hard-currency government debt and is suffering from civil unrest as the nation continues to suffer from food and fuel shortages. To make things worse, most commodities are priced in U.S. dollars, and many other countries with a high percentage of dollar-denominated debt are also at risk of following suit, including Argentina, Columbia, and Indonesia.³

Hitting a little closer to home is the impact that the strong dollar has on the earnings of America’s largest multinational corporations. With over 50 percent of revenue coming from overseas for several sectors such as technology and basic materials, companies are feeling the impact of adjusting overseas earnings back to U.S. dollars. In June, Microsoft Corporation reduced its earnings guidance, citing a $300 million reduction in revenue due to the strong dollar. Corporate profits after tax make up roughly 11 percent of GDP, making the value of the dollar a significant contributor to the overall health of the economy.⁴

Although several dozen countries have already increased interest rates this year, many central banks such as the European Central Bank (ECB) and Bank of Japan have not done so at the pace of the Federal Reserve. This has driven a gap in interest rates that could attract even more investors to the U.S and may signal that we’re only at the beginning of the dollar rally. To echo that, the Fed has suggested that it will do whatever it takes to tame inflation, even if it means allowing the dollar to run higher.

Sources:

1. Matt Turner, “Stats: Americans Travel to Europe will be up 600% over last summer,” Travel Agent Central, April 20, 2022, https://www.travelagentcentral.com/europe/american-travel-europe-will-be-600-over-last-summer

2. “Chanel Price Increase 2022: All the information you need,” ChicPursuit.com, June 7, 2022, https://chicpursuit.com/chanel-price-increase/

3. Paulina Restrepo Echavarria ,  Praew Grittayaphong, “Dollar-Dominated Public Debt in Asia and Latin America,” Federal Reserve of St. Louis, August 3, 2021, https://www.stlouisfed.org/on-the-economy/2021/august/dollar-exposure-public-debt-asia-latin-america

4. U.S. Bureau of Economic Analysis, Corporate Profits After Tax (without IVA and CCAdj) [CP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CP, August 4, 2022.