If you've been paying attention to current macroeconomic conditions, it's likely you've heard the U.S. dollar (USD) is gaining strength globally despite unsustainable inflation domestically.
Just last week, the Japanese yen sank to a 24-year low against the USD as the euro fell to parity for the first time in 20 years.
At first thought, a strong dollar sounds like a great thing. Who doesn't like cheaper imported goods and European vacations at a fraction of last summer's costs?
However, zoom out and dig a little deeper, and you might be left wondering, "Is a strong dollar really ALL good?"
How the dollar's strength is measured
The U.S. Dollar Index (USDX) - aka DXY aka "the Dixie" - is a measure of the value of the USD relative to a basket of six foreign currencies - the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona.
The index was created in 1974 with a base value of 100 shortly after the Bretton Woods Agreement was dissolved. The rise and fall of the USD is measured against this base value.
For example, DXY is trading at about 106 today. This means the USD has gained 6% versus the six foreign currencies in the basket. If it trades at 95, this means the USD is 5% weaker.
Pro Tip: The DXY is a simple metric for small business leaders to follow. It answers, "How strong/weak is the dollar?" in seconds.
Why the dollar is getting stronger
In an effort to fight high inflation, the US Federal Reserve has been hiking interest rates aggressively all year.
Dozens of central banks followed suit, but two in particular have not - Japan and Europe.
Japan is practicing yield curve control, a risky policy where the Japanese central bank inflates the money supply to buy their own bonds and maintain interest rates low at 0.25%.
Europe is experiencing record inflation, yet maintained interest rates negative for ELEVEN YEARS! The European Central Bank (ECB) raised their target interest rate 50 basis points 3 days ago, bringing its deposit rate to zero. Finally.
You know what happens when investors holding 2-year Japanese or German bonds experience negative or barely-positive nominal yields?
They sell those bonds and buy 2-year U.S. Treasuries in search of nominal returns over 3%. In other words, they sell Japanese yen and/or euros to buy USD.
When global demand for the USD is robust (like it is today), the dollar gets stronger.
In the long run, the strong dollar is a global wrecking ball
The strong dollar puts pressure on countries with USD-denominated debt, which is basically the whole world.
It devalues their currencies and impacts their ability to meet interest payments and debt obligations. It forces countries to inflate their currencies to buy more USD. This inevitably leads to hyperinflation.
Hyperinflation inevitably leads to civil unrest. The two unsettle investor outlook for the global economy.
In short, it f*kcs up the money.
The US Federal Reserve is stuck between a rock and a hard place
The Fed is trying hard to fight high inflation, yet financial stability could break in a lot of places if they continue raising interest rates. There are plenty of financial pressures popping up in the system today.
No one, including us, the mighty United States of America, the country with the strong dollar, is immune from the pain of global hyperinflation and civil unrest. Our economies are inextricably linked.
The unforeseen domino effects of financial instability around the world are difficult to predict. We can only hope for the best and prepare for the worst.
Macroeconomic uncertainty sucks for small businesses
It's tough to operate in an environment where nearly everything, including especially commodities and raw materials, is volatile and mis-priced.
Boom and bust cycles are painful. They force small businesses and everyday people to go further out on the risk curve.
They turn us into gamblers and speculators when we signed up to be honest, hard-working people simply trying to add value and build businesses that solve problems.
Time to exit the casino
Back to the basics.
Time to ask the hard questions. Time to get to know ourselves and our customers. Time to know what we own and why we own it.
Time to be better.
Time to stay aware, stay educated...and most importantly, stay cool.
Talk soon,
Old Man Winter
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