At the end of World War II, thousands of U.S. soldiers stayed
behind in Europe, either as active-duty soldiers or as tourists
exploring the continent's cities and countryside.
A key source of appeal: The U.S. dollar was far more powerful
than rival European currencies, making all kinds of European
goods and services stunningly cheap.
Those days are long gone. And if you've been abroad in recent
years, you haven't been hearing much about the almighty
In fact, measured against a basket of other top currencies,
the U.S. dollar index has slid from 96 in 2004 to 88 in 2009, to
a recent 80, according to
That steady slide has had a broad set of effects on the U.S.
economy. Tourists have surely felt the pain, but many U.S.
companies have been able to find a more receptive market for
their exports. Global
, which are also denominated in dollars, have also been boosted
by a weaker greenback.
Get ready for the math to start going in reverse: In the years
ahead, the stage is set for a dollar rally, which may impact your
portfolio in unexpected ways.
To understand the looming currency reversal, it helps to know
how we got here.
First, the drop from 2004 to 2009 was due in part to the new
euro, which got off to a slow start, but then began strengthening
fairly quickly as the positive effects of the monetary union
began to spread. Then, in 2008 and 2009, the Federal Reserve
slashed interest rates to stave off an even deeper recession.
Global currency traders quickly sold their dollars and reinvested
their funds in other currencies that delivered higher interest
rates. Other countries also cut their rates, but not to the
extreme levels that the Fed had. And with U.S. rates remaining
low ever since, there's been little reason for global currency
traders to pivot back to the dollar.
Yet we now have a clear read on the future direction of U.S.
interest rates: They're going up.
First, the Fed is winding down in its bond-buying program.
Then, at some point, perhaps as soon as early 2015 (
or even later this year, as my colleague Joseph
), the Fed is expected to start boosting interest rates back to
normal levels. It will be a slow process, but by the time it is
complete, the U.S. economy may be performing in a much more
especially in relation to still-beleaguered
(Note that the euro accounts for 58% of the dollar index, with
the Japanese yen and the British pound accounting for another 12%
to 13% each.)
The dollar appeared to have put in a bottom just before the
monthly employment report in early May. The stellar jobs report
led many to conclude that the U.S. economy is moving onto a
firmer growth path, and though the dollar's recent rebound has
been modest thus far, recall from earlier that it stood above 90
a decade ago.
If the dollar strengthens around 10% over the next few years,
what kind of effects should you expect?
One of the most important impacts will be seen in oil markets.
A rise in the dollar is expected to lead to lower global oil
prices, and prices for other commodities as well, for that
matter. That's because foreign buyers, who will see their
currencies weaken relative to the dollar, will need to spend more
buy these dollar-denominated products
. That has a direct impact on demand for these commodities. That
should also blunt any inflationary pressures that emerge in the
U.S. economy as it strengthens.
U.S. exporters are less pleased about the prospect of a rising
dollar. Their goods and services become less competitive on
global markets, and their earnings are reduced as foreign-earned
profits are repatriated back into (stronger) dollars.
Another impact of a stronger dollar: The value of foreign
stocks and funds will diminish at the exact rate at which the
dollar moves against a particular currency. A 10% rise against
the euro would trigger a 10% drop in the value of a European
investment in dollar terms (all other things being equal).
The good news: The dollar's potential rebound is mostly
expected to come against major currencies like the euro. Many
emerging markets, which often possess robust growth prospects,
are expected see their currencies hold their own -- with a big
caveat: This only applies to countries that are net exporters,
many of which are in Asia and Latin America.
Risks to Consider:
The key risk to a firming dollar scenario is an expanding
U.S. trade deficit. The U.S. is sharply reducing its dependence
on imported oil, which is helping reduce America's negative trade
balances. But if the U.S. economy grows at a much more rapid rate
than those of key trading partners, then America will suck in a
lot more of their imports, which could lead the trade deficit to
Action to Take -->
There are a lot of moving parts to the changing dollar scenario.
The key takeaway is that the factors that led to the dollar's
decline appear set to reverse. It's important to look at your
whole portfolio to assess how a potential rise in the dollar
would boost or hurt any of your holdings. It's also important to
track the dollar's impact on the U.S. economy. A reversal in the
decade-long downtrend would have positive and negative effects,
depending on such factors as trade balances, interest rate
differences, oil prices, and so on.