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Weighing the stronger dollar's pros and cons

Is a rising U.S. dollar good or bad news for the typical American household?

Over the last two years or so, the greenback’s value sure has climbed. In June 2014, an index tracking the value of the dollar against other currencies stood at 101.7, whereas its latest reported value is 127.9, a jump of approximately 26 percent. 

Part of the reason for the latest bout of strengthening (the last leg up on the chart below) is the expectation among currency traders of larger government deficits and increased inflation during Donald Trump’s term as president. Both trends lead to the expectation of higher U.S. interest rates in the future. And higher rates tend to strengthen the dollar.

Trade Weighted US Dollar Index: Broad

Let’s look at the impacts. 

A stronger dollar will make imports cheaper for American consumers, but it will also make the country’s exports more expensive for foreigners. The net effect of increased imports and reduced exports would be less domestic demand for goods and services produced in the U.S. because of the drop in prices of imported goods.

Thus, while consumers in general are better off from getting cheaper imported goods, the decline in demand abroad for our more expensive exports will put downward pressure on employment. If you’re working in an export-oriented industry and lose your job because demand for American goods falls, those cheaper prices on imports won’t compensate for lost job.

There’s a caveat, however. The employment effects would be much larger and more damaging when the economy is in a deep recession compared to when it’s operating at or near full employment, as it is now. In a severe downturn, workers who lose their jobs due to a rising dollar will have difficulty finding a new one. However, when the economy is at or near full employment, the prospects of finding a new job are much higher.

Doing so will still take time, of course, and the impact on workers forced to relocate, take lower-paying positions, leave the labor force and so on must be considered in evaluating the overall costs and benefits of a stronger dollar.

Here’s an additional effect to consider. A stronger dollar improves what economists call America’s “terms of trade” with the outside world. That’s defined as how much we must pay in exports for a given quantity of imports. 

As the dollar strengthens and our terms of trade improve, we’re able to get more from foreigners for each dollar of goods we export to other countries. That improves Americans’ standard of living and provides an offset to the decline in GDP due to the fall in demand for U.S. exports.

The U.S. economy is now strengthening and approaching full employment, but it’s not quite there yet. So I expect the stronger dollar to have some employment effects, but I don’t expect them to be substantial (though, as noted above, the costs to workers forced to find a new job need to be included in the overall calculation of costs and benefits). 

In that case, the benefits from lowering the price of imports and the improvement in America’s terms of trade must be weighed against the employment and transition costs from the lower demand for exports. I don’t expect the costs and benefits to be too far apart, so the impact is roughly a wash. 

But that’s an average across the entire population. If you’re one of the workers who loses a job due to the strengthening dollar and are forced to seek employment elsewhere, the costs could be considerable.