The Almighty Dollar
It seems a constant barrage, “the US Dollar is in decline”, “the dollar’s days are numbered” and a host of similar headlines predicting the death of the US Dollar. To be sure the dollar goes through periods of strength and weakness (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 21% year to date in 2022, and more than 40% over the past decade. The Federal Reserve’s interest rate hikes, the relative strength of the US economy, and the US dollar’s ‘safe haven’ status in times of war or distress, have resulted in a spike in the US dollar. 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 exchange rate impact of foreign sales. Many companies, including big names like Nike, IBM, and Procter & Gamble, have already warned of the dollar’s impact to earnings. 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.
Slower growth in emerging markets
The strengthening dollar has been a real problem for emerging markets in 2022. Not only does a strong dollar depress the currencies of emerging market economies, the lower commodity prices lower the real earnings in those countries slowing growth. To combat this effect you 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 the truth. 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 so far this year.