The U.S. dollar is at its weakest period in recent history. While most people ultimately perceive that a weak dollar can be detrimental, many fail to notice the direct and indirect roles a weak dollar plays for consumers and investors.
A dipping dollar is driven by many factors, but most agree that the two biggest drivers are increases in the U.S. budget deficit and increases in the U.S. trade deficit, also known as the “twin deficits.” While in recent years, both of these deficits have been high, the effect has been muted somewhat by strong foreign investment in U.S. bonds and equities. However, most believe that current levels of foreign investment is not likely to continue – underscoring the toll a weak dollar can take on consumers, investors and U.S. companies.
Sometimes the negative effects of a weak dollar are fairly apparent. For example, a trip to Italy is going to cost you a lot more if you only get a fraction of a euro for each dollar you exchange. Every dollar you convert and spend abroad, depending on how the dollar is faring against that currency, may be worth significantly less than at home.
And a weak dollar doesn’t just affect your personal spending. It affects all purchases made abroad. As a leading importer of goods from other countries, a weak dollar means the United States is now buying those goods at higher prices. In terms of imported raw materials, this can mean higher costs of production, which in turn translates into higher prices of goods sold at home, fueling inflation and slowing economic growth.
This is also true of many finished goods that are produced overseas and sold here, such as electronics, which can also end up costing consumers more here.
A strong dollar encourages foreign investment. Continued weakness is likely to lead to a drop in foreign investment. If that happens, interest rates on U.S. government bonds may need to rise in order to attract more investments from abroad. And rising interest rates on U.S. treasuries are tied to many types of interest rates, including mortgage rates, which can affect homebuyers, or those who hold variable rate debt.
However, there are some benefits to a weaker U.S. dollar. The primary one is that a weak dollar makes U.S.-made goods and services cheaper to purchase abroad, increasing the nation’s exports and helping reduce the trade deficit. Changes in currency exchange rates reduce the price of the goods overseas and allow U.S. companies to more effectively compete with foreign companies in their own countries. This bodes well for multi-national companies who sell a significant portion of their goods abroad, as well as the investors who hold shares in those companies.
Domestic tourism also tends to get a boost from a weaker dollar. Not only do U.S. citizens opt to get more bang for their vacation buck by vacationing stateside, foreign tourists do as well. In a weak dollar environment, a foreign tourist can visit the United States at a discount.
The value of the U.S. dollar affects us all. Its plays a part in everything from our mortgage rates, to the cost of imports, and even our vacation decisions. While its role may sometimes seem muted, a basic understanding of the effects of a weak or strong dollar can sometimes help map out our own individual financial decisions.
Jim O’Neil is an investment executive with Dain Rauscher Inc., a member, NYSE and SIPC. These answers are for informational purposes only and should not be considered a recommendation to buy or sell any security. Send investment questions to Investor’s Forum, The Herald, P.O. Box 930, Everett, WA 98206, by fax at 425-339-3435, or via e-mail at economy@ heraldnet.com.
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