Came across the following today: “After all, a strengthening dollar is a form of tightening, and tightening is the opposite of reflation which is what the risk markets crave. A strengthening dollar means more expensive exports and a flight to quality and away from risk. Other than a debt crisis, the markets probably fear tightening more than anything else right now.” Doesn’t make sense to me. I thought we wanted a stronger dollar - increased demand for US exports, higher US interest rates; doesn’t all this lead to reflation or am I missing something?
Stronger dollar => Low demand of US exports
Strong dollar hurts US exporters since US good become more expensive in other currencies and helps countries that export to the US (Germany is one of the places I like now) because their goods become cheaper in US dollar terms for the US consumer. The quote above is equating a strenthening dollar with a decrease in risk appetite and a flight to safety amid the recent sovereign debt crises. Some people, including the esteemed Bchadwick on AF, may say that gold is a good investment because of the growing fears (founded or not) about sovereign debt defaults. Difference: Greece can’t print euros, totally different situation from most sovereign debt.
Stronger dollar is bad for US exports. Foreigners find our stuff more expensive and don’t buy as much. Higher interest rates is a related issue but best thought of separately. It is related because higher interest rates will tend to strengthen the dollar as more foreign capital comes here to take advantage of higher interest rates (provided that these are real interest rates that are rising, and not simply inflation expectations). Higher interest rates does two things: it makes it harder to borrow money for fixed capital investment and for consumption, this tends to slow growth, which is bad for markets. Higher interest rates also raise the discount factor you use to compute present value. That lowers asset values too, although not for the same reasons as reduced consumption and investment. So for stock prices, interest rate increases creates a double whammy. Therefore the short term effect of higher interest rates will be to increase the strength of the dollar. However, if rates climb so high as to stunt business and curtail economic activity, the long term effect will be to decrease the strength of the dollar.
strong dollar is viewed as slowing the economic recovery and will widen the trade deficit which may scare off trading partners.
Thanks, appreciate the insights.
the key word in the above quote is reflation and he is spot on. you want to see strength in other currencies, meaning continued buying of risk currencies, and in turn continued buying of non-dollar denominated assets. raising the price of non-dollar denominated assets will increase loan production abroad and further development of risk assets will follow. its all about expected growth differences between the U.S. and emerging markets. people hoarding USDs, means there’s less money at work in areas with RoRs which are 10x greater than U.S. RoRs.