Stronger Dollar Is Good For Economy ... Except Where It's Bad

President Harry Truman understood the upside/downside dimension to economic polices, having heard his administration's economists explain, "On the one hand, if you increase social spending, you'll address these social problems. On the other hand, it may increase inflation."

That led to Truman's famous lament, "What I wouldn't do for a one-armed economist."

Further, the upside/downside nature of economic policy also applies to the dollar: There's a better than 50/50 chance the dollar will strengthen in the year ahead, after a long period in the currency market's desert. Heck, even commodity guru Jim Rogers, chairman of Rogers Holdings and not a historical dollar bull, is buying the dollar these days. At midday on Tuesday, $1.3582 bought one euro, a gain of about 10% for the dollar since December 2009. Still, investors shouldn't view a stronger dollar is an unqualified positive or a slam-dunk economic plus for the U.S. -- not by a long shot.

A Stronger Dollar Could Hurt Exports ...

First the bad news. The chief problem problem with a stronger dollar concerns exports. A stronger dollar makes U.S exports more expensive for foreign consumers/buyers.

Moreover, the dollar's rise is occurring just when U.S. exports are starting to increase at an impressive rate: roughly 20% in the past two quarters. That surge in new business is partly due to rising demand for goods in emerging markets, but part of it has been due to the previously weak dollar, which has lowered the cost of U.S. goods. If the dollar rose another 10% or 15% versus the euro, British pound and Japanese yen, that would reduce the attractiveness of these goods on a price basis.

As a result, companies that do a lot of business abroad such as Caterpillar (CAT), Deere (DE), Boeing (BA) and General Electric (GE), could see sales hurt by a stronger dollar. Given that the U.S. economy will probably need increased international sales to make up for more restrained domestic consumer spending, the dollar's rise is occurring at an inopportune time: If a stronger dollar results in lost international sales, it would constrain U.S. GDP growth.

A stronger dollar could hurt the U.S. tourism industry. International visitors spent an estimated $121.6 billion in the U.S. in 2009, according to U.S. Commerce Department data, a 14% drop from 2008, primarily due to the global recession. The decline occurred after a pleasant five-year growth period during which international spending increased at double-digit annual rates. Once again, should the dollar strengthen versus other major currencies, that would likely hurt the sector's recovery, as the stronger dollar would make travel to the U.S. more expensive for foreign visitors, who might look for better bargains elsewhere.

... But a Stronger Dollar Would Also Attract Investors

Still, it's not all bad news. A stronger dollar does offer positives for the U.S. economy, with the perhaps the chief of these being its impact on domestic prices.

A rising dollar tends to lower inflation, particularly commodity price inflation. The price of oil, the world's most important commodity and one that's vital to the U.S. economy, is particularly sensitive to dollar movements. A stronger dollar would have the effect of capping oil price hikes in a bullish oil market, and push oil prices lower when demand for crude softens. Given how the cost of oil ripples through the U.S. economy, a lower oil price would likely restrain U.S. inflation. So when the dollar rises, don't just think higher export prices -- think lower oil prices.

Second, and equally significant, a stronger dollar boosts the attractiveness of U.S. investments. Investors scour the world in search of return and yield, and stocks in promising U.S. companies look even more attractive during a bullish dollar period. That's because foreign investors know that not only will they receive the gains from the companies' profits, but also a purchasing power "bonus," because a rising dollar means those dollar-denominated stocks will be worth more relative to their home currencies.

A stronger currency also makes it easier for a nation to borrow and finance its debt, all other factors being equal. Now, historically the U.S. Treasury hasn't had too much of a problem find buyers for U.S. bonds, but investors should rememeber that a rising dollar increases the attractiveness of U.S. investments, including U.S. government bonds. That increased buyer demand can lower the interest rate the federal government pays to finance its debt.

And, obviously, a stronger dollar lowers the cost of international travel for Americans. Anyone who has vacationed in Mexico's delightful seaside resorts in Los Cabos can tell you the trip is always more pleasant when the dollar is strong and buys 15 Mexican pesos, as opposed to when it buys only 10 pesos.

In sum, all other factors being equal, it's better for a nation to have a stronger currency because it usually means its economy is growing, its fiscal and monetary policies are sound and its products and services are competitive in global markets. However, without question, a stronger currency is a two-edged sword. Particularly regarding a stronger dollar, there is an "on one hand, on the other hand" dimension to it.

And by now, you're probably saying, "What I wouldn't do for a one-armed currency reviewer."
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