Economics 101 tells us that when a country’s inflation rises, the value of its currency tends to drop. However, that’s far from the case with the U.S. dollar. Despite scorching inflation in recent months, the dollar has appreciated significantly against major foreign currencies including the British pound, the euro and Japanese yen.
On July 14, the dollar and the euro reached parity for the first time in 20 years. The exchange rate provides a rare boon for American travelers in Europe but spells warning for major U.S. exporters, such as Boeing, and multinational corporations that generate overseas revenues in foreign currencies.
The U.S. dollar index, which measures the value of the dollar relative to a basket of foreign currencies, is up 13 percent this year. That means a default discount for consumers who buy things with dollar in many countries.
In Paris, American tourists have embarked on shopping sprees at luxury stores, and many at home are planning shopping trips to Europe, according to Reuters and the Wall Street Journal. Reuters reported tourism spending in Europe jumped 400 percent in June from a year ago, when the pandemic depressed travel
But for businesses, a rising dollar means their products are getting more expensive to foreign buyers and their overseas revenue loses value when converted from local currencies to the greenback.
Boeing, the largest exporter in the U.S., recently lost a huge order of nearly 300 commercial jets purchased by the Chinese government, to Europe-based Airbus. China has historically split jet purchases evenly between Europe and the U.S., but the balance has begun to tilt. This year so far, Boeing has delivered only one commercial jet to China, while Airbus has delivered 47. Neither China nor Boeing nor China cited exchange rates as a factor in the recent jet order. In a statement on July 1, Boeing called China’s purchase “a disappointment.”
Software and consumer goods companies are also cutting their outlook for international markets. Microsoft, Coca-Cola and Procter & Gamble are among some U.S. multinationals that have lowered earnings forecast for the rest of 2022 due to exchange-rate risks.
What keeps the dollar strong amid high inflation?
“The ongoing recovery from the pandemic, as well as the rapidity with which the Federal Reserve has responded to inflationary pressures, account for some of the dollar’s strength,” said Peter C. Earle, an economist with American Institute for Economic Research, a think tank.
Since the beginning of the year, the Fed has raised interest rates multiple times in an attempt to quell inflation. Europe is facing similarly steep inflation stemming from the war in Ukraine, but the European central bank has yet to raise rates as aggressively as the Fed. In Japan, where inflation is much more subdued, the Bank of Japan has kept its main rate at near zero.
That means interest-bearing assets denominated in U.S. dollars are more attractive to investors compared with assets based on foreign currencies. Like goods and services, the value of a currency is determined by supply and demand. As investors flock to the dollar, the value of other currencies drop.
Also fueling the demand for dollar-based assets is growing economic and geopolitical uncertainties, Earle added. As of June, the U.S. dollar accounts for almost 60 percent of global central bank reserves, according to the International Monetary Fund.
Mixed impact on American consumers and businesses
Domestically, the impact of a strong dollar means cheaper imports, which “blunts some of pain of mounting inflation for American consumers,” said Earle of the American Institute for Economic Research.
Thanks to a strong dollar, the price of imports, excluding fuel, has been falling for two consecutive months, according to the Labor Department‘s most recent reading on July 15. Over the past year, prices of non-fuel imports rose by 4.6 percent in June, roughly half of the increase of overall consumer prices.