Financial Insights: Two Cheers for the Declining Dollar

With the economy in full recovery, the pessimists around us have to find another thing to worry about. These days, the decline in the dollar’s value appears to be the bete noir of choice. Instead of wringing our hands over the dollar’s decline, we should be cheering. As was the case 20 years ago, the U.S. economy is again outperforming its European and Japanese counterparts. Again, the U.S. has a sizable trade deficit. And again, the U.S. dollar is under pressure. As the French would say, plus ca change, plus c’est la meme chose (translation: the more it changes, the more it’s the same).
The pessimists fear that a declining dollar will cause foreigners to cease investing in the U.S. economy. If foreign investment dries up, then the dollar will drop even more as interest rates soar. For the pessimists in the crowd, this combination of events will push the U.S. economy over into a recession. The pessimists’ solution to this problem is to increase aggregate savings through tax hikes and reduced consumer spending. If the U.S. can slow economic growth to the tortoise pace of the Europeans or Japanese, then our trade balance will begin to right itself.
Over the years, the dollar has had its ups and downs. The dollar soared between 1980 and 1985. Tax reduction, economic deregulation, and strong U.S. economic growth brought a large U.S. trade deficit and a surge of foreign investment.
The dollar’s sharp decline between 1985 and 1987 was of greater magnitude and duration than the current slide. It was driven in large part by a slowdown in foreign investment from low triple-digit to high single-digit growth. During this period, despite the dollar’s decline and the rising of interest rates, the economy continued to expand and foreigners still brought their investment dollars to the U.S.
This period of sharp dollar decline ended in 1987 with the stock market crash but even that event did not stop the flow of foreign investment into the U.S. The dollar continued to decline for another eight years, albeit in a more orderly fashion, and that did not seem to have much impact on foreign investment in the U.S. Only the recession year of 1991 saw foreigners take money out of the U.S. economy. The economic lesson here is clear — the lack of real growth, not trade imbalances nor even the dollar’s value are what deter foreign investment.
While the pessimists would like to see higher taxes and a slowdown in the U.S. economy as a solution to the dollar and trade imbalances, a much better solution would be to encourage faster growth outside of the U.S. Our large trade deficit is boosting otherwise anemic European and Japanese economies. Simultaneously, the declining dollar is making oil cheaper for the Japanese and Europeans and should actually help their economies. As such, the decline has to be viewed as a positive for the global economy, worth at least a cheer or two.

Implications for Mass Merchants
While a falling dollar is a positive for the broad economy, it creates a number of challenges for mass merchant retailers. Mass merchants have relied on imported goods, particularly from China to keep a cap on their cost of goods sold. So far, the decline in the dollar has done nothing to the dollar-yuan exchange rate. That is likely to change. A revaluation of the yuan would lift some of the pressure off of the dollar elsewhere. It would also push up the price of Chinese goods. In anticipation of such a revaluation, it would be prudent for mass merchants to begin seeking non-Chinese sources for goods. The decline in the dollar is also a factor in the rise in the price of oil. Higher oil prices reduce consumer purchasing power for non-oil related goods and act like a tax on consumer spending.

Implications for Convenience Stores
The falling dollar also creates a number of challenges for convenience store retailers. Some of the recent rise in the price of oil can be traced directly to the decline in the dollar. The price of oil is priced in dollars globally. A declining dollar means that oil in yen and euros is getting cheaper, pushing up non-U.S. demand and the price of oil in dollars. Rising gasoline prices make it challenging for convenience stores to maintain margins on gas.

Implications for Food Stores
It would be easy to assume that a declining dollar has little impact on food stores. That assumption would be wrong. Over the past two years, food imports have grown at double-digit rates as importers have expanded their share of the U.S. market. Food retailers have used imports to keep costs down, while expanding the variety of their merchandise mix. A falling dollar will make those imports more expensive.