Retirement Red Zone

April 2022

Contributors: Colby McFadden, Justin Singletary, and Patrick Morehead

How the US Dollar Affects Economies

How a Greenback Can Affect your Retirement Red Zone

With the U.S. Dollar being the world currency for trade, changes in the relative strength of the U.S. Dollar compared to other world currencies can have many effects on industries, global economies and asset prices within your investment accounts.  As investing becomes more global it’s important for investors to understand how currency fluctuations can affect the stock market and global economies.

How does the U.S. Dollar affect the U.S. and Global Economies?

For most of the last century, the preeminent role of the U.S. dollar in the global economy has been supported by the size and strength of the U.S. economy, its stability and openness to trade and capital flows, strong property rights, and the rule of law. As a result, the depth and liquidity of U.S. financial markets are unmatched and have positioned the U.S. Dollar as the reserve and trade currency of the world.  Changes in the relative strength of the U.S. Dollar compared to other world currencies can have many effects on industries, global economies, and asset prices.

In global economies, a stronger dollar tends to reduce liquidity in global markets because it means other currencies are worth fewer dollars which is the dominant currency in trade and financial markets.  This can be a negative for the economic growth of non-U.S. Dollar-using countries, especially emerging markets.

The effect of the stronger dollar on industry is mixed. For instance, most global commodities are priced in US dollars, so a stronger greenback may reduce overseas demand and thus affect the revenues and profitability of US resource producers. Manufacturing companies are hit especially hard by the rising dollar, as they have to compete in a global market and a domestic currency that is even 5% stronger can have a considerable impact on their competitiveness.

On the other hand, an appreciating dollar benefits companies that import a great deal of machinery and equipment, like engineering and industrial companies, since these would now cost less in dollar terms.

The stronger dollar gives the biggest advantage to companies that import most of their goods but sell domestically, since their top-line and bottom-line benefit from robust domestic demand and lower input costs.  

On the flip side of this, sales and earnings for US multinationals that sell their products and services globally would be negatively affected by the stronger dollar. Pharmaceuticals and technology are two sectors where US firms have a major presence around the world, so they are substantially affected by a rising greenback.

As you can see, a rising and falling Dollar can have a multitude of effects on global economies as well as the industries that influence the ups and downs of investment asset classes for investors.

How does the U.S. Dollar affect the Stock Market?

The U.S. dollar and the stock market have a mostly one-way, inverse relationship. The majority of the impact flows from the dollar -- the cause -- to the stock market -- the effect. Historically the perception has been that when the dollar rises, the stock market falls and vice versa.  There are a few logical reasons for this to occur and a few reasons that seem illogical.

On the logical side, stocks of companies that rely on commodities, like those that grow crops or extract metals, gain a direct positive benefit from a weaker dollar. A weaker dollar usually pushes commodity prices higher, in dollar terms. Since each dollar buys less material, companies that sell commodities pay the same to extract the material but get more dollars when it is sold. This boosts profits. The United States is the world's largest agricultural exporter, according to the USDA, and a weaker dollar increases the competitiveness of these exports abroad. The companies benefit from increased foreign sales, and the share price rises when earnings are reported.

On the illogical side,  the U.S. might be the biggest economy, but it still makes up only a significant minority, and not the majority, of the global economy. Companies realize this, which is one reason they operate overseas. Companies doing a significant portion of their business overseas will be strongly affected by foreign exchange fluctuations against the dollar. If a company makes 1 million euros in profit, and the dollar falls in value, then those euros will translate to more dollars. The market swoons when those extra unearned profits come in. It sounds ridiculous if you look at companies for the strength of their business, but the stock market involves a lot of perception, not just economic realities.

The U.S. Dollar During times of Crisis

In crises, the dollar tends to appreciate and dollar liquidity becomes scarce.  

Why is this?

The textbook answer is, since the US dollar is the world’s dominant currency, the United States benefits from paying low interest rates on safe (risk-free) dollar-denominated assets, such as the bonds issued by the US government. When global risk aversion is elevated, investors tend to hedge against uncertainty by switching to dollar-denominated assets as part of their “flight to safety”.

If you think of a crisis as a set of events originating from a variety of shocks causing a drop in consumption across a number of countries and a depreciation of their currencies you can start to see how the process of “flight to safety” would create an increase in demand for dollars subsequently putting upward pressure on the value of The Dollar relative to other global currencies. 

How this may affect various investments.

Over the long-term (10+ years) currency fluctuations between the various countries tend to balance out. But in the short-to-intermediate-term (1-5 years) currencies can fluctuate all over the place and see large relative gains or losses. 

Depending upon the time frame of an investor's goals these fluctuations over the short-to-intermediate term time frame in the U.S. Dollar can have drastic effects on whether that investor reaches those goals or comes up shy of those goals.  This is most relevant for investors that may find themselves within a “Red Zone” of life where they may need a significant portion of their invested dollars for a life change like retirement or a change in health within the next 5-7 years.  For these investors, understanding how to optimize their investment portfolio with Dollar strength and weakness as a major consideration is just as pertinent if not more pertinent to achieving financial goals than having just a “diversified portfolio”. 

Markets are acting up.  Make sure to stay on top of what we are watching.  Read our most recent Market Minutes From The Boardroom for actionable insights on the market's most recent moves!

Meet Our Contributers

Colby McFadden Founder, Quiver Financial

Justin Singletary Director of Retirement Services, Quiver Financial

Patrick Morehead Director of Alternative Investments, Quiver Financial

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