The U.S. dollar has been depreciating against many foreign currencies lately. This started with a recent rumor that energy-producing countries were set to stop pricing oil in U.S. dollars and sent the dollar tumbling. This particular rumor turned out to be false but a confirmed signal from the Federal Reserve this week did not help matters. Regardless of the shorter term news flow (and whether it is true or not), confidence in the dollar is shaky and a weak domestic currency will likely be the norm going forward for a couple of fundamental reasons.
A Weak Dollar is Here to Stay
At the Fed’s latest policy meeting, it stated that it is unlikely to raise interest rates given that the economy remains on tepid footing. Higher interest rates drive demand for currencies. For instance, certain investors speculate in the carry trade, borrowing currencies with low interest rates and using those funds to purchase currencies with high interest rates in an attempt to profit from the differential.
Dollar confidence is also running low because of the huge current-account deficits run up from U.S. consumers demanding the import of far more goods than are exported to overseas trading partners. To fund the difference, countries including China and Japan have had to fund the imbalance by buying dollar-denominated assets, such as U.S. Treasury bonds. This is proving unsustainable over the longer term and will likely eliminate one of the primary demand drivers for the dollar in recent years.
Benefits of a Weak Dollar
A key benefit is that a weak dollar encourages exports as foreigners use their respective strong currencies to purchase U.S. goods and services on the cheap. The same goes for travel as it becomes quite affordable to stay at a hotel and shopping is much more fun when discounts are widely available. In other words, a weak dollar can be the friend of a firm that sells goods outside of the U.S. or is involved in tourism.
A weak dollar also positively impacts businesses that sell overseas because of the benefits of translating strong foreign currencies back to the U.S. dollar. Firms also like to release results in constant currencies, or the removing of foreign exchange movements to better reflect true demand for products, but there is still an accounting benefit to a weak domestic currency when operating internationally that can turn real when funds are brought back home to the U.S.
The flip side to all of this is that it becomes more expensive to travel overseas and buy raw materials or related goods from abroad. Currency fluctuation is also a moot point in China or any country that tries to control its currency and doesn’t allow it to float freely on the open market. As a final consideration, firms can choose to hedge any foreign currency exposure as a means to ride out the inevitable ups and downs that go with doing business on a global scale. Overall, businesses can pull a few levers to try and minimize short-term fluctuations in currencies, which can at times become quite volatile and as illustrated above can be influenced by unsubstantiated rumors. The bottom line is that if overseas markets are a current or anticipated focus for your business, make arrangements for further dollar weakness.