Wednesday, January 12, 2011

Is It Better To Have STRONG dollar or a weak dollar?

If you go out and ask random people man-on-the-street style whether we are better off with a strong dollar or a weak dollar, I would wager said dollar that most people would answer "strong".  After all, a strong dollar conjures up images of muscular George Washington with a Rambo-style headband beating the stuffing out of a weakling euro, thus proving the superiority of the American financial system.  Besides, isn't it better to be strong rather than weak?

What does a strong dollar mean anyway?

The dollar is said to be strong if you can exchange a dollar for larger amount of a foreign currency.  The dollar is said to be weak if you can exchange a dollar for a smaller amount of a foreign currency.  To illustrate the point, here is a graph which shows how many euros for which a dollar could be exchanged over the past five years (courtesy of Yahoo! Finance):

Looking at the graph, you can see that at the beginning of 2006, you could trade a dollar for about 0.84 euros.  However, fast forward to mid-2008, you could only trade a dollar for about 0.64 euros.  One could say that in 2006, the dollar was strong in comparison to the euro.  However, in 2008, the dollar was weak. That is because every dollar could be exchanged for fewer euros in 2008 than you could in 2006.

Now that brings us back to the question at hand:  is it better to be able to trade a dollar for more euros or less?

Well it depends on your point of view.

If you are an American student backpacking across Europe, you would prefer a stronger dollar.  If you left home with $1000 in your pocket in 2006, you would be able to exchange that for 840 euros.  However, if you started your journey in 2008, you would only be able to trade your money for 640 euros.  Obviously, 840 euros is going to last longer than 640 euros.

On the other hand, if you are the owner of a bed and breakfast in the U.S., you would prefer a weaker dollar.  When the dollar is weak, a room at your inn is going to appear cheaper to a European tourist who comes to the U.S. with a pocket full of euros.  In 2006, 1000 euros is going to translate into about $1190.  However, in 2008, that same 1000 euros is going to be worth about $1560.  Because Europeans are going to be able to exchange their money for more dollars, they might be enticed to cross the pond for a vacation, rather than staying closer to home.

The same is true for imports and exports.  When the dollar is weak, it benefits U.S. companies which want to export their goods abroad.  When the company sells its products in Europe, consumers pay for those products in euros.  The company must then exchange these euros for dollars in order to pay its workers, suppliers, and shareholders.  If the dollar is weak, those euros will be exchanged for more dollars, thus benefiting net exporters.

On the other hand, when the dollar is strong, it benefits companies which import goods from abroad.  When a company buys a product from Europe, it must trade its dollars for euros in order to make the purchase.  If the dollar is strong, the company can trade its dollars for more euros, thus the price of the foreign goods is that much cheaper to the American firm.

Which is better then:  strong or weak?  A strong dollar means that the cost of goods from abroad are cheaper.  Since the U.S. is a net importer, that sounds pretty darn good.  All of those imports are cheaper when the dollar is strong.  On the other hand, a weak dollar benefits U.S. companies.  Because imports are relatively more expensive, domestic firms are better able to compete.  Likewise, a weak dollar means that U.S. exports are more lucrative.  Both of these things could mean more jobs of American workers.

As you can see, there isn't a right answer.

The interesting thing is that the U.S. has been accusing China of keeping the value of its currency artificially low.  The U.S. believes that if China were to raise its official exchange rate (thus making the dollar weaker relative to the Chinese yuan), it would make it easier for U.S. companies to sell their products in China, and it might stem the tide of cheap Chinese imports into the U.S.  This is a case where the U.S. Government believes that weakness is strength.

The bottom line is that you shouldn't assume that stronger is better when it comes to the dollar.

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