The dollar rises and falls measured against other currencies, with some short-term volatility. But there is an overall trend.
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During the last few years, the dollar has been declining in value relative to other currencies. In fact, since 2002, the dollar has depreciated 40 percent against the currencies of other major developed countries.
The decline in the relative value of the dollar and the weakness of the U.S. financial sector make dollars less attractive to hold. Currently, interest rates in the United States are very low. While low interest rates could help the economic recovery, they are not attractive to investors.
To varying degrees around the globe, central banks are diversifying their reserves into euros, pounds and yen. The Chinese have even called for the creation of a super-sovereign currency to replace the dollar as the reserve currency of choice.
On the other hand, the dollar is strengthened by the fact that the United States has never defaulted on its debt. In addition, the nation has political and military stability, making the dollar a relatively safe currency. And, currently, the United States has relatively low inflation.
Whether the dollar will continue to decline – and, if so, how much – is a matter of speculation. But what would a weak dollar mean for the economy? Is it necessarily true, with regard to the dollar, that strong is good and weak is bad?
Advantages and disadvantages of a weak dollar
A weak dollar can be a good thing for U.S. firms who want to sell goods in foreign markets. Because foreign products and services become relatively more expensive, U.S. products and services become more competitive overseas.
Also, there is less competitive pressure from foreign products and services in the U.S. market, making it easier for U.S. firms to raise prices within the United States. Thus, for some businesses, a weaker dollar offers opportunities. Investors can evaluate whether particular domestic companies they are considering for investment might become more profitable if the dollar falls.
U.S. capital markets also become more attractive to foreign investors if the dollar weakens. U.S. real estate and companies become more tempting targets for non-U.S. investors. Foreign sources are more willing to provide capital during times of heavy borrowing if the dollar is weak.
Tourism may benefit from a weaker dollar because the United States becomes more affordable for foreigners. An increase in tourism is a significant benefit. Its contribution to the economy ranges from 4 percent to 11 percent, depending on how broadly the sector is measured, according to a report from the World Economic Forum.
Conversely, tourism in foreign countries becomes more costly for U.S. citizens if the dollar falls relative to the currency in those countries. So, citizens are more likely to spend their vacation dollars within the United States.
On the downside, a weak dollar means foreign products and services are more expensive to U.S. consumers. To the extent such products continue to be purchased, the cost of living will rise, which in turn will affect consumer choices.
To the extent foreign products are not purchased, companies that depend upon sales of such products may suffer a loss of business. And, for U.S. producers that do not rely solely on U.S. labor and materials, the cost of foreign inputs into production rises when the dollar falls.
A weak dollar makes it harder for U.S. firms to expand into foreign markets because the dollar doesn’t go as far as it used to.
Declining dollar and oil
Perhaps most worrisome, a weak dollar could have a great impact on the cost of oil.
If the dollar declines in value, consumers will have to spend a higher percentage of their income on gasoline and heating costs, leaving less money available to purchase other goods and services. Businesses that use petroleum products in producing their goods and services would also see costs rise.
When considering whether and where to invest if the dollar continues to decline, it is appropriate to factor in the effect oil prices would have on the companies being considered.
