Back in the depths of the last recession in 2008 the U.S. dollar was considered toast. Everyone was convinced the days of global greenback dominance were over. It was just a matter of time before China would dump its U.S. Treasury holdings and move to a stronger currency.
Well, five years later things look a lot different (see chart at the bottom). The dollar has appreciated 35% from its low against the Euro. China’s holdings of Treasury securities have not only not declined but have increased 75% since 2008.
Currencies move in relation to a country’s economic fortunes and its interest rates. Rising rates and a stronger economy attract funds and this drives up a currency’s value. I realize currency swings are a lot more complicated than this, but still this is a good starting point.
Right now the conventional wisdom says the dollar should gain more strength in 2015. The U.S. economy is doing better than the rest of the developed world and the Fed is signaling that this is the year it will finally start increasing rates. This should help the dollar.
But like all things, a rising price puts in place many of the factors which lead to a future decline. Markets are not a perfect metronome but a rising dollar does make our exports more expensive which, all things being equal, leads to a weaker economy and eventually a weaker dollar.
But things may not play out this way today. The rest of world is more dependent on foreign trade than we are. In Germany and South Korea for instance, exports account for 50% to 55% of total GDP. In the U.S., trade is only 14% of GDP which means that exports, although important, are not the same driving force they are elsewhere.
We all like the idea of a ‘strong dollar’. It sounds good. It brings with it a lot of good things (imports are cheaper, travel to Europe less expensive) but also bad things (our exports are less competitive, and emerging countries have a harder time paying their dollar denominated debt). A lot of the discussion around the dollar conjures up scary images. A ‘weak dollar’ sounds bad but remember it doesn’t mean we are going out of business just like a ‘strong dollar’ doesn’t mean our future will be bright indefinitely. Some things like currencies, do seem to swing like a metronome. Don’t get too wrapped up in the emotional debate.