Exchange rates are not only important to foreign exchange dealers wearing fancy headgear and staring at monitors in closed dealing rooms. Exchange rates have a huge impact on our lives, whether we care about them or not. Exchange rates affect almost everything around us, from ramen at convenience stores to new apartments for sale. In particular, citizens of emerging countries where the external value of their national currency is weak must be subject to the ups and downs of exchange rate fluctuations every day, regardless of their will. If so, wouldn't Americans who hold the dollar, the king of currencies around the world, be completely unaffected by the exchange rate? Let’s change our perspective and think about it from an American’s perspective.
household chores
A strong dollar makes American imports cheaper. It lowers inflation in the United States and lowers the cost of living. A strong dollar allows Americans to buy more things. But more importantly, it allows Americans to save more money without compromising their quality of life.
They have the ability to save for a rainy day (accident) or retirement. This is in contrast to the people of emerging countries who only look at a handful of severance pay and national pension. In comparison, a weak dollar increases the prices of goods imported from the United States. Their standard of living is lowered because they have to pay more for vegetables, jeans, etc. imported from nearby countries such as Canada and Mexico. A weak dollar erodes the dollar's purchasing power and causes inflation. This is one of the reasons why the U.S. Federal Reserve (Fed) has sharply raised interest rates since March 2022.
oil price
When the dollar strengthens, that is, when the value of the dollar rises compared to other countries' currencies, gasoline prices in the United States fall. Why. This is because more than 70% of U.S. gasoline prices depend on international oil prices. All oil contracts around the world are concluded in dollars. Saudi Arabia, which sells most of the world's oil, pegs its currency, the rial, to the dollar. Fixing the exchange rate between the dollar and its own currency, like Saudi Arabia does, is called a peg, meaning 'driving a wedge.' It becomes a crocodile bird riding on the back of a crocodile. When the value of the dollar rises, the value of the rial also rises. This makes daily necessities imported from Saudi Arabia cheaper.
Therefore, Saudi Arabia has room to lower oil prices when the dollar rises. On the other hand, when the dollar weakens, oil prices rise. This is because the rial, which is pegged to the dollar, also weakens. Saudi Arabia must raise oil prices to maintain revenue from oil sales, which accounts for most of the country's finances. Saudi Arabia must increase its oil exports because the prices of daily necessities it imports are higher. Although the U.S. dollar has recently strengthened, a strange phenomenon has occurred in which gasoline prices in the U.S. have soared. This is because the domestic movement of Americans has increased explosively since the lifting of COVID-19. The inflationary pressure on the demand side overwhelmed the exchange rate effect.
industry and jobs
A strong dollar is bad for American exporters. That means American exporters export less. Why. This is because a strong dollar makes American products more expensive than foreign products. If this continues, economic growth will slow down. This forces American companies to outsource jobs overseas. Foreign workers are typically paid in their home currency, which is weak against the dollar, so it costs less for U.S. companies. A strong dollar also hurts U.S. domestic companies. They compete with cheaper imports. American consumers prefer cheaper imported products over expensive American products. American manufacturers must lower prices to remain competitive. Lower product prices mean that a company's profitability will slow down. A strong dollar slows economic growth. If economic growth slows, jobs for American workers will decrease. This is why the U.S. Federal Reserve is currently considering an interest rate cut despite inflationary pressures.
loan
A strong dollar means strong demand for U.S. Treasury bonds. Most overseas countries purchase U.S. Treasury bonds to expand their foreign exchange reserves. U.S. Treasury bonds are the most stable in the world and pay interest. The reason other countries hold U.S. currency is so that their trading companies can easily transact with U.S. companies. Most of the world's trade is settled in dollars. As demand for U.S. Treasury bonds increases, U.S. Treasury bond prices rise and U.S. Treasury interest rates (yields) decrease. Interest income is fixed, but as the investment principal increases, the yield on government bonds decreases. As government bond yields fall, the interest rates on newly issued government bonds also fall. These government bond interest rates directly affect other bond interest rates, especially mortgage (home loan) interest rates. As mid- to long-term government bond yields rise, housing loan interest rates also rise. When government bond yields fall, mortgage interest rates also fall, making home loans more affordable. These falling interest rates are an incentive for people to spend more money on building and purchasing homes. Increasing real estate demand promotes gross domestic product (GDP) growth.
On the other hand, a weaker dollar means higher interest rates in the United States. Here, the interest rate refers to the market interest rate formed in the market, not the base interest rate that the central bank arbitrarily controls. First of all, a weak dollar means there is not enough demand for government bonds. Therefore, the U.S. government is trying to raise government bond interest rates to attract more investors. And because a weak dollar causes inflation, the Federal Reserve wants to raise the federal funds rate. The Fed's goal is to keep inflation below 2%. Recently, inflation in an emerging country has consistently exceeded 3%. I am envious of the talent of central banks in emerging countries that have achieved inflation rates similar to those of the United States, which spent astronomical amounts of helicopter money while releasing almost no money during the COVID-19 period.
stock investment
A strong dollar could help or hurt the U.S. stock market. Foreign investors buy dollars when they think the U.S. economy is strong. In this case, the possibility that foreign investors will invest in American companies through the stock market also increases. On the other hand, a strong dollar makes U.S. stocks expensive. Foreign investors are hesitant to purchase U.S. stocks because they have to buy cheap and sell high to make a profit. If foreign investors already own U.S. stocks, a weaker dollar helps. This is because the value of existing stocks appears to be higher thanks to the exchange rate. A weak dollar helps exports. Increased exports strengthen economic growth. This situation makes American stocks cheaper compared to foreign stocks.
Overseas Travel
The exchange rate tells international travelers how much they can purchase at their destination. When the dollar is strong, Americans can buy more things abroad. When the dollar is weak, everything Americans buy abroad becomes more expensive. If the dollar weakens, Americans will be more likely to postpone international travel. However, there are also ways to avoid the influence of exchange rates. Travel to countries that peg their currency to the dollar, such as Saudi Arabia or Hong Kong. In those countries, travel does not become more expensive when the dollar falls. The dollar is strong right now, making it a good time for Americans to travel to any country in the world.
But an important question was left out. What is the exchange rate? It is literally an exchange rate. What is the exchange ratio? It is the exchange rate between money and money, that is, the price of money. Under the gold standard, there were both internal exchange rates (exchange rates between gold and paper money) and external exchange rates (exchange rates between domestic paper money and foreign paper money). However, after then-U.S. President Richard Nixon's declaration of gold non-conversion in 1971 (a declaration of national default that would not pay gold even if dollars were imported), gold coins disappeared from the earth and only paper money remained. So today, when economists talk about exchange rates, they mean external exchange rates.