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  • Writer's pictureSteve Coker, CFP

The Almighty Dollar


It seems a constant barrage, “the US Dollar is in decline”, “the dollar’s days are numbered” and a host of other similar headlines predicting the death of the US Dollar. To be sure the dollar has declined against a basket of global currencies since the 70’s (see chart below), but it is actually the dollar’s strength, not its weakness that has many economists wringing their hands right now. The dollar has risen 34% over the past 4 years and has spiked this year. Furthermore, the dollar's strength could continue, driven by a comparatively strong economy and a central bank that is raising rates. It is likely that we will hear much more about the strength of the US Dollar in the weeks to come. Here is what a strong dollar could mean to the global economy.

Headwinds to US Earnings

US companies with significant international exposure could see a reduction in earnings due to the impact of exchange rate fluctuations on foreign sales. For example, Pepsi warned this week that exchange rate translation could shave 11 percent off of full-year core earnings per share. In contrast, telecoms and utilities who derive most or all of their income from domestic sources will see little impact. Because not all companies will be affected equally, a strong dollar does not necessarily translate into a decline in the S&P500. What it does mean is that investors should be wary of companies that have historically been driven by international growth.

Lower Commodity Prices

As the dollar strengthens the price of commodities will decline in dollar terms, impacting the earnings of commodities companies. For example, the dramatic decline in the price of oil this year, while primarily due to oversupply, was exacerbated by a strong dollar. Similarly, the price of gold has been driven lower over the past 4 years due to dollar strength. A strong dollar could continue to represent a headwind to these companies.

Slower Growth in Emerging Markets

The strengthening dollar has been a real problem for emerging markets in 2015. Not only does a strong dollar depress the currencies of emerging market economies, lower commodity prices decrease the real earnings in those countries, thereby slowing growth. To combat this effect, we have seen many central banks sell their dollars as they intervene to support their own currencies and help keep the US Dollar in check. Ironically, the gold bulls use the central bank selling to claim the dollar is done as the world’s reserve currency. The opposite is actually true. The central bank selling is evidence that the US Dollar is the world’s reserve currency.

The death of the dollar has been greatly exaggerated and this year’s spike in the dollar is a great lesson for those who claim to be able to predict its demise. It is somewhat ironic that those who have called for a decline in the dollar have received exactly the opposite. As investors, we needn’t fear a weak dollar or a strong dollar, but it is important to be aware of what is happening. If the strong dollar continues we should expect headwinds for US earnings, lower commodity prices, and slower growth in emerging economies. Given these themes, we feel confident that our portfolios are positioned appropriately.

Druck, Pablo, Magud, Nicholas, and Mariscal, Rodrigo. "Collateral Damage: Dollar Strenght and Emerging Markets' Growth." IMF Working Papers. July 2015. https://www.imf.org/external/pubs/ft/wp/2015/wp15179.pdf.

Whipp, Lindsey. "Pepsi Expects Strong Dollar for 'Years to Come'." Financial Times. October 6, 2015. http://www.ft.com/intl/cms/s/0/896956ba-6c21-11e5-8171-ba1968cf791a.html#axzz3oJa3PG2N

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