Strong Dollar: Advantages and Disadvantages

A strong U.S. dollar has several advantages and disadvantages. It benefits some but negatively impacts others.

The dollar is considered strong when it rises in value against other currencies in the foreign exchange market. A strengthening U.S. dollar means it can buy more foreign currency than before. For example, a strong dollar benefits Americans traveling overseas because $1 buys more; however, this would disadvantage foreign tourists visiting the U.S. because their currency would buy less.

If you're looking for a way to gauge the dollar's strength, one of the best ways is to watch the Invesco DB U.S. Dollar Index Bullish Fund (UUP). This exchange-traded fund tracks an index that represents the value of a dollar compared to its exchange rate versus a basket of important foreign currencies, including the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.

Advantages of a Strong Dollar

Traveling Abroad Is Cheaper

Americans using U.S. dollars can see those dollars go further abroad, affording them a greater degree of buying power overseas. Because local prices in foreign countries are not significantly influenced by changes in the U.S. economy, a strong dollar can buy more goods when converted to the local currency.

Expatriates, or U.S. citizens living and working overseas, will also see their cost of living decrease if they still use or are paid in dollars. 

Imports Are Cheaper

Goods produced abroad and imported to the United States will be cheaper if the manufacturer's currency falls in value compared to the dollar. Luxury cars from Europe, such as Audi, Mercedes, BMW, Porsche, and Ferrari, would all fall in dollar price.

For example, if a European luxury car costs €70,000 with an exchange rate of $1.35 per euro, it will cost $94,500. The same car selling for the same amount of euros would cost $78,400 if the exchange rate fell to $1.12 per euro.

If the dollar continues its strengthening trend, import prices will likely keep falling. In theory, this leaves U.S. consumers with more disposable income as long as all other economic factors remain the same. Assuming the same steady economic factors, U.S. companies that import raw materials from abroad will have a lower total cost of production and enjoy larger profit margins.

Multinationals That Do Business in the U.S. Benefit

Foreign companies that do a lot of business in the U.S. and their investors benefit from a strengthening dollar. Multinational corporations with large sales in the U.S., which earn income in dollars, will see gains in the dollar translate to gains on their income statements and balance sheets. Investors in these companies should be rewarded, as well.

Status as World's Reserve Currency Is Bolstered

A strong dollar bolsters the dollar's status as a world reserve currency. While some countries, including Russia, Iran, and China, have questioned the status of the U.S. dollar as the de facto world reserve currency, a strong dollar helps keep its demand as a reserve high. 

Disadvantages of a Strong Dollar

Tourism to the U.S. Is More Expensive

Visitors from abroad will find the prices of goods and services in America more expensive with a stronger dollar. Business travelers and foreigners living in the U.S. but holding on to foreign-denominated bank accounts, or who are paid incomes in their home currency, will see their cost of living increase.

Exporters Suffer

Just as imports become cheaper at home, domestically produced goods become relatively more expensive abroad. An American-made car that costs $30,000 would cost €22,222 in Europe, with an exchange rate of $1.35 per euro; however, it increases to €26,786 when the dollar strengthens to $1.12 per euro. Some have argued that expensive exports can cost American jobs.

U.S. Companies Conducting Business Abroad Are Hurt

Companies based in the United States that conduct a large portion of their business around the globe will suffer as the income they earn from foreign sales will decrease in value on their income statements. Investors in such companies are also likely to see a negative impact.

McDonald's Corp. (MCD) and Philip Morris International Inc. (PM) are well-known examples of U.S. companies with a large percentage of sales occurring overseas. While some of these companies use derivatives to hedge their currency exposures, not all do, and those that do hedge may only do so in part.

Emerging Market Economies Are Negatively Impacted

Foreign governments that require U.S. dollar reserves will end up paying relatively more to obtain those dollars. This is especially important in emerging market economies because it reduces the profits of exporting businesses in those economies.

Special Considerations

Economic theory predicts that currency fluctuations will eventually revert to a mean since cheap foreign goods should increase their demand, raising their prices. At the same time, expensive domestic exports will have to fall in price as demand for those items declines worldwide until some equilibrium exchange level is found.

It's also important to remember that a strengthening dollar may not always increase purchasing power for U.S. dollar users. During periods of an increasing rate of inflation, purchasing power goes down. So if U.S. inflation increases and dollar strength matches it with a similar rise, the two might cancel each other out.

But there is a caveat—if all countries the dollar is gaining against are experiencing a rise in inflation along with the U.S., then dollar purchasing power should rise also. This would act to counter the effects of rising inflation, as demonstrated during the rapid global inflationary increase from 2020 to 2022 and into 2023, while the dollar still gathered strength.

The Bottom Line

A strong dollar allows U.S. consumers to purchase goods and services from overseas for less than if the dollar was weaker. It also helps compensate for rising inflation by keeping purchasing power from dropping too much.

Businesses that export and do most of their business overseas become disadvantaged by a strong dollar because they tend to see reduced revenues from the areas the dollar is strong against. But generally, it is good for the U.S. economy to have a strong dollar.