Politics

What Does A Strong Dollar Mean?

What Does A Strong Dollar Mean? by Ben Strubel, Strubel Investment Management

Dear Investors,

This months’ newsletter features some commentary on what a strong dollar is and isn’t and how it might affect the economy as well as a link to an article we wrote about why we are soon ready to sell GameStop (GME).

What does a strong dollar mean? Most people assume that a strong dollar is a good thing, after all the word “strong” has a much more positive connotation then the word “weak”. So, strong must be good and weak must be bad right? Furthermore, you often read anecdotes about how the US dollar has lost 90 some percent of its “value” since such and such date. Sounds like it got weaker right? You look around at your everyday expenses: food, mortgage payments, car payments, healthcare, etc. Expenses are going up but your wages stay the same. If only “your” dollar went further and was “stronger”. That’s how lots of people view things. They are correct in how they feel but they are using the wrong terminology to describe what they’d like.

Before we talk about what a strong dollar actually means let’s talk about the two things people often the term with first.

The first thing that people often mean when talking about a strong dollar usually has something to do with the inflation. The old “back in my day a soda used to cost a nickel!” phrase usually comes to mind. While prices have indeed gone up, wages have risen as well (although wages as we will go over in the next section wages have stagnated for many people in the last few decades). For example in 1947 the median family income was $3,031 and the average price of a new car was $1,864. So it took about 61.5% of a family’s income to buy a new car. In 2013 the average price of a new car rose to $31,252. That’s inflation of almost 1,576%! Except that the median family income in 2013 was $51,017. That means that a new car cost about 61.3% of a family’s median income. So, inflation or as some people refer to it the fall of the value of a dollar has not had any effect on affordability. Both prices and wages have gone up. Your dollar might not be worth the same as one in 1947 but you have a lot more of them!

Now, it’s important to note that some areas of the economy suffer from much higher rates of inflation and affordability issues. These issues can be caused by a variety of reasons such as poor government policies, lack of regulation, monopolistic practices by corporations, and on and on. For example, college tuition rates have risen fast in part due to ever increasing subsidized loans backed by the government, internet and cable TV remains expensive due to monopolistic industry practices, and the price of basic commodities have increased due to government deregulation of commodities trading just to name a few. So, while there can be “inflation” issues none of them have to do with the strength or purchasing power of the dollar.

The second thing people confuse a strong dollar with is the wage level in the economy. People think if I earn the same wages I earn now but soda only costs a nickel then I would be better off. This is a good segue way to our second point about wages. Most people feel they are underworked and overpaid, and they are correct! Since the 1970s not only have real wages of most non-supervisory personnel not followed productivity gains (that is, as an economy grows so too should wages) but real wage levels have essentially been flat for most employees. The chart below shows wages for non-supervisory personnel versus productivity levels (this would be lower level, non-management workers).

Strong Dollar

When you add in the wages of managers and executives and look at all workers, the picture improves somewhat as you can see below (but the average wage level still lags productivity growth).

Strong Dollar

What you have is an economy where most of the income growth is flowing towards the top .1% to 1% percent and to the corporate sector (particularly large, multinational corporations).

So when someone is complaining about the affordability of living on their current salary they are not talking about the relative strength or weakness of the dollar, they are talking mainly about the distribution of income within the economy.

So what does a strong dollar actually mean? Well, the relative strength of the dollar is the value of the dollar compared to foreign currencies such as the Euro, Yen, Pound, or Swiss Franc. If the dollar strengthens it means that a dollar buys more of the foreign currency. For example suppose the current exchange rate for dollars and euros was equal, 1 dollar bought 1 euro. Now supposed the dollar got stronger. Now 1 dollar might buy 2 euros. Conversely if the dollar got weaker it might take 2 dollars to buy 1 euro.

When a currency gains in strength it also means that exports from your country are less attractive. If we wanted to export a widget worth 1 dollar (or 1 euro because we are assuming parity for this example) to France, but the dollar doubled in strength all of a sudden our  1 dollar widget would cost the French 2 euros instead of just 1. If the French wanted to export a bottle of wine (it’s OK if I include one French stereotype right?) that cost 100 euros (or 100 dollars because we are starting off assuming parity) but the dollar doubled in strength that bottle of wine would now only cost 50 dollars.

When the currency of a country gains in strength is that exports tend to fall since the goods from our country are now more expensive and imports tend to rise since other countries exports are now cheaper. This tends to have a negative effect on economies. Since a country is exporting less and importing more cheap goods from abroad (the difference between exports and imports is called the trade deficit or surplus, importing more than you export means you have a trade deficit) this means that jobs start to disappear. Now, if a government properly managed the economy it would not necessarily be bad. For instance if the government saw that the currency was gaining strength they could step in with a package of tax cuts and stimulus spending to make sure the job market and economy stayed on track. Not only would we get the benefit of cheap imported goods but we’d also have full employment here and full output so we’d get the benefit of everything we could produce ourselves as well. But, take a look at the clowns on both sides of the aisle in the US and tell me if you think that is likely.

Instead what we will likely have is a bit of self-correcting behavior. The strong dollar will likely lead to a slowdown in the economy. Because of the slowing economy the dollar will then likely weaken. Once the dollar weaken