Strong Dollar Good, Weak Dollar Bad?

Filed in archive Economy on November 6, 2007

I often hear or read about the US dollar being strong or weak versus other currencies, but I never really know what that means, why I should care, or how it affects me. Instead of wallowing in my ignorance, I finally went looking for answers today.

Due to my overall laziness, I started and ended my research with this publication from the Federal Reserve Bank of Chicago - Strong Dollar, Weak Dollar: Foreign Exchange Rates and the US Economy. I expected the document to be boring and over my head, but for the most part it was really well-written and made sense, without a lot of jargon that would be meaningless to the layman.

Here's some of what I learned:

* Neither a strong dollar nor a weak dollar is all good or all bad. For example, while a strong dollar is great when you are traveling to other countries because of the excellent exchange rate, it also hurts U.S. companies that want to export goods to other countries, because our goods are then more expensive and less competitive in those markets (and their imports are cheaper in our markets, which can also hurt our country's businesses). And vice versa-when the dollar is weak, you get bad exchange rates and foreign travel is expensive, but U.S. businesses can export more and be more competitive in international markets. Overall, though, a strong dollar is better.

* The strength or weakness of the dollar can be affected by many factors, including interest rates, inflation, our economy's perceived strength and stability versus that of other countries, and whether our government is running a deficit or surplus.

* There is no governing body that mandates what the exchange rate between currencies will be. There is a foreign exchange market (forex) where traders buy and sell currency in the same way stocks are bought and sold. So, a currency's strength or weakness can be about perception as much as reality, just like with a stock. There are underlying reasons behind the ups and downs in currencies, but it is still human beings making educated decisions about the relative strengths and weaknesses of each country that determines how strong the country's currency is.

* Surprising to me was the idea that our government running a deficit could actually be seen as a way to make the dollar stronger. The reason for that is because when we're borrowing from other countries, we're actually offering stronger interest rates than they can usually find in their home markets, so they want to buy our dollars to play in our interest rate marketplace.

* Our dollar can weaken even when our economy is going strong and inflation is in check, if other countries are doing well, especially if those other countries are improving from a recent point of economic weakness. And vice versa-our dollar can strengthen against other currencies even when our economy is lousy, if those other countries' economies are even lousier.

I would encourage you to read the document for yourself if you'd like to get a better handle on these concepts, if for no other reason than you'll appear smart at parties should this question come up. (And God knows it comes up at every party I attend; I hang with a swinging crowd.) There's also a decent chance that I interpreted something wrong, so please don't just take my word for it.

BTW, if you don't live in the United States, these concepts are the same for your money, too.