U.S. Dollar, Showing Some Muscle, Hits 14-Month High

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The beaten up, down-but-not-out greenback is making a comeback, rising about 10% in the last month and 17% since the beginning of the year versus European currencies. On Thursday, it hit the highest level for the year.The beaten up, down-but-not-out greenback is making a comeback, rising about 10% in the last month and 17% since the beginning of the year versus European currencies. On Thursday, it hit the highest level for the year.

Economists and businesses know all too well that while there are upsides to having a strong dollar, there are also downsides. And no one has the definitive answer as to which is actually better for investors or the U.S. economy.

The renewed strength of the dollar comes as economies overseas are being propped up with bailouts and riddled with uncertainty. The euro hit a 14-month low against the dollar Thursday to about $1.256.

More Big Mac for Your Dollar

Using The Economist's Big Mac index to illustrate the drop of the euro against the dollar, in November 2009, a $3.58 Big Mac would have cost you $5.41 in Europe, based on the exchange rates at the time. On Thursday, that Big Mac in Europe cost $4.50, or 17% less.

The euro has been rapidly losing value due to the financial woes of its member countries. In the last week, the euro countries got a $1 trillion financial bailout package, offering a short-term boost for the European currency. Yet concern that it may not be enough pulled the euro down.

"I wouldn't think of it as the dollar getting stronger so much as the euro and other currencies getting weaker," says economist William Conerly. "This uncertainty is just eroding their currencies, making the dollar seem stronger."

Dollar Surges With Other Safety Nets

The dollar is showing strength against the Japanese yen and the British pound. The recent uptick for the dollar is attributed to investors looking for safer investments as the markets show instability. Gold, the ultimate safe harbor investment, is trading at record levels.

Clearly there are benefits for U.S. travelers heading overseas, in terms of getting more for their dollar, and it also benefits companies that are purchasing goods from foreign countries. A strong greenback also helps hold down inflation.

On the flip side, U.S. companies with operations abroad are likely to take an earnings hit because of the stronger dollar. Even while their international operations bring in the same revenues, they will actually earn less when they exchange those foreign funds into dollars.

"As the dollar appreciates, U.S. goods become less competitive in the global economy as it diminishes the purchasing power for foreign entities," says David Song, a currency analyst with DailyFX.

Not for the Faint of Heart

Morgan Stanley estimated that in March of this year the 500 companies that make up the S&P 500 stock index received 31% of their revenues from outside the U.S., and that could translate into lower earnings when they convert from other currencies back to the dollar.

Robert Dekle, a University of Southern California professor of economics, says that big companies that have global operations are likely to be somewhat protected from currency swings. These companies simply ramp up operations where currency is cheap. It's the smaller and mid-sized exporters that are going to take a hit if the dollar keeps its strength. The larger ones can hedge against currency risks, Dekle says.

For investors, pouring money into currency is not without a lot of risk -- there's a reason currency traders call it a zero-sum game. As Song says, you can't just dabble in currencies, and investors should be aware of the dynamics of the currency market as well as the fundamental and technical factors that affect the major exchange rates.

"If you end up making money on one currency, it is because another, probably smarter, person lost money," Conerly says. "It is one of the hardest investments to forecast."
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