What are the consequences of a strong dollar? We spoke with experts

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Entering the eurozone during a period of significant euro weakening, thus strengthening the dollar, is certainly not a fortunate situation. However, is this a reason for deep and long-term concern? Although many economists and analysts warn that parity itself is not a key variable – what is crucial is what is happening (and as a consequence of the euro’s weakening, due to sanctions and the state of the energy market) with the bonds of European member states, which are sinking – the equalization is not a historical sensation.

Nevertheless, ignoring the collapse of bonds, possibly not only of the PIIGS countries, would be quite foolish, but we have already written about this in Lider, so we will focus on other aspects of the consequences of the dollar’s strengthening.

It is not the first time such oscillations occur among currencies

Analyst Velimir Šonje claims that the dollar’s exchange rate has not significantly changed since the moment of the euro’s birth when in January 1999, one euro cost about a dollar and five cents. – After that, the dollar strengthened, and in November 2000, one could buy a euro for just eighty-five cents.

After a brief floundering at the bottom, a significant recovery of the euro followed from 2002 to 2008. At that time, one had to pay almost a dollar and sixty cents for a euro, which is double the amount compared to six years earlier. After the outbreak of the 2008 crisis, the dollar entered another long cycle of strengthening, with significant short-term fluctuations up and down. Investing.com displayed the exchange rate of a hypothetical euro before 1999 (what the exchange rate would have been if the euro had existed earlier, which largely depends on the then DEM/USD exchange rate).

Interestingly, the weakness of the euro from 2000 to 2002 was not the period of the greatest weakness of European currencies against the dollar. In the mid-1980s, the exchange rate equivalent of the euro was below seventy cents for a dollar – Šonje points out, adding that the EUR/USD exchange rate moves in long historical cycles around which shorter ones dance, and around them revolve ultra-short-term fluctuations.

It is easier for America than for Europe

Some general patterns are nonetheless emerging: in good times, the euro rises, and the dollar falls, while in bad times, the reverse is true (as everyone in fear rushes to the dollar as a safe haven). Also, America navigates bad times more easily, as it is economically and politically more dynamic than slow Europe, leading to quicker decision-making, faster economic reactions, and America often moving more swiftly into a cycle of rising interest rates, which also favors the dollar for some time. We are currently in such a cycle that has lasted for fifteen months – concludes Šonje.

Economist and professor Ljubo Jurčić states that there are three key reasons for the dollar’s strengthening. – Interest rates are higher in the U.S., and investors always invest where the interest rate is higher. Increased investments strengthen the dollar. The geopolitical situation also works in their favor; if any projectile falls within the EU, production stops, and all capital shifts to the U.S.

Additionally, the U.S. is investing enormous resources in armament, and due to the current war, this boosts production and employment, as demand for goods and workers rises. Furthermore, if Russia cuts off gas in the long term, Europe is surely sliding into recession, and no one knows what its multiplicative effect will be – thinks Jurčić.

When asked how a strong dollar affects other goods and services in the market, he states that this is not the best news for the U.S., as it significantly raises their overall export prices while simultaneously lowering European export prices. However, this rule is currently somewhat disrupted by geopolitics and war, as in the energy situation, if the Russians indeed cut off gas supply or if Europe completely turns to other sources, this is excellent news for the U.S. and very bad for the EU, as it will be forced to buy gas at a significantly higher price.

Problems are inevitable 

Logically, all prices of goods in dollars are rising (oil, gas, copper, aluminum, wheat…), and this constitutes the majority on global commodity exchanges (a relatively smaller portion of raw materials is procured/contracted on European exchanges). Companies that procure goods from the U.S. face problems, as they will pay a higher price.

The problem for those who will buy dollars or purchase in dollars is that it is not just ten percent more expensive, but also twenty percent because a strong dollar is compounded by high American inflation. On the other hand, everyone who works around the world and receives a salary in dollars, such as (Croatian) sailors, will benefit.

All countries whose external debt (or at least part of it) is expressed in dollars will also face problems. However, it should be noted that most countries have hedged such debt and thus protected it from exchange rate fluctuations. Croatia, fortunately, left the dollar debt market long ago, so today only about five percent of its debt is in dollars.

Šonje adds that the only channel of influence in which the EUR/USD exchange rate is important for domestic prices is the import prices of some energy sources that are paid in dollars. – A stronger dollar raises energy prices if their dollar price does not change. Currently, this is not the case despite the dollar’s strengthening to parity, as dollar prices for crude oil have fallen more in the past few weeks than the dollar has strengthened.

'We will deal more with the world that affects us'

However, if we look at a longer period, the past year, we will see that both factors have acted unfavorably: the world price of oil (in dollars) has risen by about fifty percent, and the stronger dollar has added another about fifteen percent to that. However, before that, there have been, and in the future there will be, periods in which the constellation of exchange rates and raw material prices will align in ways that will work in our favor – Šonje is categorical, stating that two key lessons emerge.

–  The EUR/USD market is the largest market in the world with millions of participants. Through this market, the entire economic and political history of the world is refracted, or, if you want to be a little less dramatic, through this market, the largest part of the influence of international exchange flows and international financial flows is refracted.

It will be interesting to observe how the focus of the domestic public, previously obsessed with the exchange rate of the kuna to the euro (previously to the German mark), will shift to a much broader currency field (which will be beneficial for everyone, as we will engage more with the world that affects us, and less with our idyllic little village). Secondly, the EUR/USD exchange rate is not important for Croatia’s decision to join the euro area; all the influences of changes in the dollar’s value will flow to us in the same way as has been the case so far, as the value of the kuna against the dollar has changed approximately in the same way as the value of the euro.

In conclusion, he states that we should not be concerned about the equalization of parity, just as the majority of the eleven who formed the euro in 1999 were not concerned, including Greece, which joined in 2001, Slovenia in 2007, Cyprus and Malta in 2008, Slovakia in 2009, Estonia in 2011, Latvia in 2014, and Lithuania in 2015. Slovenia, he says, did not care about the dollar when it introduced the euro at an EUR/USD exchange rate of 1.3, Malta did not care when it introduced it at 1.51, nor did Lithuania at a drastically different 1.07.