The Almighty Dollar Prospers-or Does It?

The US dollar is an important currencyin world markets, and plays a majorrole in international commerce. Not onlyis the dollar used for most of the tradewith this country, but it's also the preferredcurrency for trade in many othercountries. And while fluctuations in theexchange rates are reported in the press,many investors often overlook howchanges in the value of the dollar itselfcan have significant bearing on our owninvestments here at home.

Since the early 1970s, the dollar hasbeen allowed to "float" against manyother currencies (ie, the actual value ofthe dollar is set in free markets governedby the laws of supply and demand). So,when other countries want more dollarsto buy US goods, services, or assets, thevalue of the dollar will generally rise relativeto the value of foreign currencies. Ifthe demand for the dollar shrinks, then itsvalue tends to decline and it weakens.

Sometimes a strong dollar is good,dampening inflation by making importsless expensive. When the economy isweak, a weaker dollar can be helpful.

THE HAPPY WEAK DOLLAR

A weak dollar helps American manufacturersby making their goods morecompetitively priced when compared withforeign imports. When a dollar can't buyas much abroad, it makes imported goods,in effect, more expensive. The resultinghigher import prices tend to lead companiesand consumers to purchase moredomestic goods. This can give US companiesa competitive pricing advantage, justwhen the economy is weak and US businessescould use a little extra help.

To illustrate this point, let's look at anexample. Confronted with the choicebetween an American-made watch and aforeign model, both priced at $100, consumershave a decision to make basedmostly on product features and function.But if the value of the dollar declined inthe foreign marketplace, the store sellingthose watches would not be able to purchasethe foreign model at the same price.

Consequently, the amount of money—in dollar terms—needed for the retailer toacquire foreign-made watches wouldincrease. As a result, the price for the consumerwould go up as well. If the store hasto sell that same foreign watch for $103,customers may decide to go with theAmerican product simply because it carriesthe lower price tag.

A DOLLAR IN DEMAND

On the other hand, the opposite is truewhen the value of our currency appreciatesdue to higher world demand for thedollar. Keep in mind that the value of thedollar in the world marketplace is basedon supply and demand of the dollar itself.If that value increases, American consumersand businesses that buy goods,services, or materials from abroad are theones who benefit from increased purchasingpower of their dollars.

Going back to our watch example, anappreciated dollar could buy more foreignproducts. So if the retail price of theimport watch drops to $95, consumersmay be lured away from the American-madegoods simply because of the costsavings. Granted, this is an extremely simplifiedexample. But it demonstrates theidea that a declining dollar can benefitdomestic products and producers, while arising dollar can benefit those who purchaseforeign goods.

A strong dollar does hurt domestic producerswho try to sell abroad, such asfarmers and manufacturers. But one of thebenefits of a strong or appreciating currencyis that it helps to keep domesticinflation in check, while a weak or depreciatingcurrency tends to increase the dollar'schances of inflation.

When the economy struggles, the valueof the dollar may drop. But the weakerdollar leads to future benefits by makingthe price of American products much morecompetitive in the world markets. As aresult—barring an overly extended declinein the dollar—US businesses could regainmarket shares lost to cheaper imports.

Joseph F. Lagowski is VP/investmentsand a financial consultantwith A.G. Edwards in Hillsborough, NJ. He welcomesquestions or comments from readers at 800-288-0901 orwww.agedwards.com/fc/joseph.lagowski. Thisarticle was provided by A.G. Edwards & Sons, Inc, member SIPC.