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Why the Strong US Dollar Has a Dark Side

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The sunshine

The US dollar has strengthened against its peers like the euro, the yen, and the British pound. The PowerShares DB US Dollar Index Bullish Fund (UUP), which tracks the performance of the greenback versus the euro, the yen, the British pound, the Canadian dollar, the Swedish krona, and the Swiss franc, is up 21% from a year ago. Those invested in this or similar ETFs, or in currency pairs favoring the dollar per se, are grinning from ear to ear. However, there is a dark side to a strong dollar.

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The clouds

A strong currency is bad for exports of the home country. This is so because a strong unit of exchange automatically makes a country’s goods and services expensive on the international market. In order to remain competitive, exporters may be forced to reduce the sales price of their goods. If not compensated by a commensurate rise in volumes, this reduction in sales price would be detrimental to a company’s revenues.

The impact of this strong dollar has been such that companies like International Business Machines Corporation (IBM), Proctor & Gamble (PG), and Honeywell International (HON) have already announced that a stronger dollar will negatively impact their profits. Other large exporters like ExxonMobil (XOM) and Oracle (ORCL) are also negatively impacted by a strong greenback.

With the US looking at tightening its monetary policy by raising the federal funds rate, while most other economies are easing theirs, the dollar is expected to appreciate further. There is a small silver lining on account of this easing, though. Economies of large trading partners of the US like the Eurozone and Japan, which are easing monetary conditions in their respective areas, are expected to bounce back. This may raise the demand for US exports.

However, this remains to be seen. Until such a time, net exports, which are negative presently, will continue to put pressure on the economic growth of the US.

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