Is a strong dollar good for America? Well, it depends.
Principle #9: Globalization has positive and negative effects on different groups.
Objectives:
Distinguish a strong dollar from a weak dollar
Identify the determinants of the strength/price of a currency
Identify the distributive effects of the strength of a currency
Why you want to know this
If you ever buy anything that is made in another country, if you ever plan to travel outside the country, if you ever work for a business that sells to people in other countries, this lesson is for you.
A strong dollar vs. a weak dollar
If you are travelling in a foreign country, you are likely to need some of the currency of that country. In Mexico, you will use pesos, in Canada Canadian dollars, in Germany Euros. You can buy these currencies just like you can buy a dozen eggs, by paying with dollars. And just like eggs, these currencies can be a bargain, or they can be expensive. If the dollar can buy many pesos, it is said to be strong against the peso; if it can buy fewer pesos than a month ago, it is said to have weakened against the peso. A strong dollar can buy lots of the foreign currency, a weak dollar not so much. For example, assume that one month ago, a US dollar could buy 18.5 pesos, and today, it can only buy 17 pesos. The dollar has weakened against the peso. Conversely, the peso has strengthened against the dollar. Notice that a weak dollar or a strong peso is a comparison between time periods. The fact that the peso has strengthened against the dollar does not make the peso a strong currency by nature; it is a strong currency compared to a month ago.
How many pesos can a dollar buy? | What is the price of a 100 peso Mexican product in dollars? | |
Stronger dollar | 25 | $4 |
Weaker dollar | 20 | $5 |
As a US consumer, do you want a stronger dollar or a weaker dollar? __________________
How many dollars can 100 pesos buy | What is the price of a $100 US product in pesos? | |
Stronger dollar /weaker Mexican peso | 4 | 25 pesos |
Weaker dollar/stronger Mexican peso | 5 | 20 pesos |
As a US seller of US products to consumers in Mexico, remembering the law of demand,
do you want a strong or a weak dollar? _______________________________
What determines the price of a currency?! You should know the answer by now. Like the price of any product, the price of labor, the price of credit, the price of a currency is determined by the interaction of buyers and sellers. It’s a matter of supply and demand. The dollar, the rupee, the Mexican peso, all national currencies are bought and sold on foreign exchange markets and their prices are determined on those markets. So what determines the price of a currency in terms of another currency, the price of a Euro against the Indian Rupee (how many Rupees does it take to buy a Euro?) or the price of a US dollar against the Japanese Yen (how many Yen does it take to buy a dollar?) Once again, as in all markets, the price is determined by the supply of and demand for the product, in this case currency.
The next obvious question is, “What forces influence the supply of and demand for a currency?” Let’s use the dollar as an example. What influences the demand by foreigners for the dollar and the supply of dollars on the world market? It’s actually pretty simple.
Let’s start with demand. Why would foreigners want to buy dollars?
US products - If they wish to purchase U.S. products, they create a demand for dollars to pay for them.
Relative interest rates – If people plan on holding on to their savings for a while, they are likely to “shop the world” for the most advantageous interest rates. If those in the US are higher than elsewhere, they are likely to use their domestic currencies to buy dollars to save in the US.
Financial Investment – If rates of return are high in the U.S. relative to other countries, foreigners will take their currencies, trade them for dollars, and invest those dollars in high interest financial opportunities in America.
Relative return on real investments – Foreigners are likely to buy property and other “real” assets if profits in these assets are higher than similar investments in other nations.
Safety - Foreigners seeking a safe haven for their wealth often buy dollars and deposit them in American banks which are considered safe compared to many nations that don’t enjoy the security of the rule of law.
Now let’s turn to supply. Why would US folks want to supply dollars to purchase other currencies?
US imports – When Americans buy foreign products, they either directly or indirectly supply US dollars to the foreign sellers of those products.
Americans travelling abroad – US tourists buy foreign goods and services, paying for them with foreign currencies purchased with US dollars.
People in America sending dollars “back home” – US residents send dollars to relatives in their native countries
US foreign aid – The US government sends dollars to foreign governments to aid their people
Higher interest rates, rates of return on financial and real investments – higher rates in foreign nations will attract dollars just as higher rates in the US will attract foreign currencies.
The table below summarizes the influences on the demand and supply of dollars by holders of foreign currencies.
Demand for Dollars | Supply of Dollars |
Demand for U.S. products (Increased demand for U.S. products causes increased demand for dollars and vice versa.) | Purchase of foreign products by Americans (Increased purchase of foreign products increases supply of dollars and vice versa) |
U.S. interest rates relative to foreign interest rates (Higher U.S. interest rates causes higher demand for dollars and vice versa.) | Gifts to foreign individuals and governments |
U.S. profit rates relative to foreign profit rates (Higher U.S. profit rates cause higher demand for dollars and vice versa.) | American overseas investment |
U.S. and foreign government intervention (official buying of U.S. dollars by governments) | U.S. and foreign government intervention |
Political and economic conditions in U.S. and foreign countries | Political and economic conditions in U.S. and foreign countries |
So the price of a dollar in terms of Euros and the price of a Mexican peso in terms of Canadian dollars, like all other prices, are determined by supply and demand. A strong dollar means that the dollar can buy more of other currencies and more foreign goods and services.
Distributive effects of the strength of the dollar
So a strong dollar must be good for America…. right? Well, as with most questions in economics, the correct answer is, “It depends.”
If you are planning to travel to a foreign country, you want a strong dollar because you will be able to get more of the foreign currency for your dollar. If your business imports foreign products, you want a strong dollar because you can get more product for your buck. If you send dollars back to your family in a foreign country, you want a strong dollar because it will allow your family to buy more stuff. BUT, if your business depends heavily on selling your products overseas, a strong dollar means that your stuff will be more expensive in foreign currencies. Remembering the Law of Demand, a stronger dollar means higher prices in the customers’ country, which means your customers will buy fewer products from you. If you have savings or investments overseas, a strong dollar means a weaker foreign currency. Your saving in that currency is worth less in terms of dollars. A strong dollar (weak foreign currency) hurts those who sell their products abroad, those who save their dollars in foreign currency, and many others. So, to answer the question, “Is a strong dollar good for America?” you would have to reply that it helps some and hurts others. It is not a matter of national pride; it is a matter of helping and hurting.
Bottom line:
The strength or weakness of the dollar is a relative matter…relative to another currency and relative to previous time periods.
The price of the dollar in terms of another currency (exchange rate) is a matter of supply and demand.
A strong/weak dollar has distributive effects; it helps some Americans and hurts others.
1. Which of the following is the strongest dollar?
a. 1 dollar can buy 5 rupees
b. 1 dollar can buy 1.3 Euros
c. 1 dollar can buy 25 Yen
d. Insufficient information
2. Which of the following is the weakest Euro (€)
a. 1 € can buy $2
b. 1 € can buy $1.2
c. 1 € can buy $1.3
d. 1 € can buy $1
3. Which of the following would want a strong dollar?
a. A European tourist travelling in the U.S.
b. An American tourist travelling in China
c. An American farm equipment producer selling to Europeans
d. All of the above
4. Which of the following would strengthen the dollar?
a. Increased demand for American products
b. Rising interest rates in the U.S. relative to interest rates in other countries
c. U.S. Treasury purchases of dollars on the world market
d. All of the above
5. Which of the following would an American farm equipment producer selling to Europeans favor?
a. U.S. Treasury purchases of dollars on the world market
b. Rising interest rates in the U.S. relative to interest rates in other countries
c. Increased supply of dollars on the world market
d. None of the above
The Chinese have been accused of intentionally weakening their currency. Why would they do that?
Former President Trump once asked his economic advisor whether a strong dollar was good for America. How would you answer him?