Consequences of a strong dollar

   Over the last 12 months, the U.S. dollar has increased in value by 12.5 percent against other world currencies, according to the trade-weighted index published by the Federal Reserve. This has direct and indirect consequences for U.S. trade. 
   While the U.S. economy has been improving, European and Asian economies have remained weak. Europe had to deal with the public finance crisis in Greece, while China continues to withdraw from using infrastructure investments to support growth. In both Europe and Asia, central banks earlier this year started lowering interest rates and engaging in policies similar to those the Fed used to help the U.S. economy recover. These efforts are beginning to take effect in Europe, but not yet in Asia. 
   A strengthening U.S. economy alone would have helped the dollar gain value. Slower growth in other major economies added further momentum to the dollar’s momentum. 

First effect of a stronger dollar.   A stronger dollar makes U.S. imports cheaper and its exports more expensive to foreign consumers. Thus, imports have been growing faster than most forecasters expected. Forecasts for exports were low because of low growth in foreign economies; however, it is likely that the stronger dollar pushed low growth into an outright decline in exports because foreign importers appear to have shifted away from expensive U.S. goods. 
   The United States has run a large trade deficit for the better part of the last 20 years. This is largely because the United States tends to export commodities with a low value to weight ratio compared to the manufactured goods it imports. According to Census Bureau data, U.S. export tonnage is greater than import tonnage.
   The bottom line is that a stronger dollar increases the U.S. trade deficit.
Second effect: Lower commodity prices.   Over the last 20 years commodity prices have been negatively correlated with the strength of the U.S. dollar. The graph below inverts commodity prices to better illustrate how the two indexes trend together.
   The basic argument for this inverse relationship is that most commodity prices and contracts are denominated in U.S. dollars. As the dollar gains value, buyers in countries whose currency has depreciated have to pay higher prices when measured in their domestic currency. This reduces the quantity demanded and more often than not the commodity price declines in order to clear the market.
   It is worth noting that in the last decade or so commodity production capacity has outpaced demand growth. This is particularly true for energy commodities and some metals. Commodity prices tend to decline when supply grows faster than demand.
   The bottom line is that the recent commodity price boom is over for at least a few years.

Third effect: Lower economic growth.   Commodity producers, such as oil and mining companies and farmers, will have lower revenues and, therefore, lower profit. Many of these companies have been reducing production, laying off workers and postponing investments in plants, property and equipment.
   The bottom line is that export-oriented industries, which were helping the economy recover, are now retrenching.

Role of infrastructure.   There is not a lot that domestic policy makers can do to combat these significant macroeconomic trends. The United States could help its export industries by investing in export supply chain infrastructure, such as inland waterways, deficient bridges, and rail and highway connections to major seaports. Unfortunately, the country has postponed major policy decisions regarding infrastructure investment and exporters now have to contend with not only a stronger dollar pricing them out of the market but also high freight transportation costs due to insufficient capacity and crumbling infrastructure. Better export infrastructure could help to minimize the export impacts of a stronger dollar.
   Kemmsies is chief economist at Moffatt & Nichol, an infrastructure engineering firm. He can be reached at (212) 768-7454, or email at wkemmsies@moffattnichol.com.

This column was published in the September 2015 issue of American Shipper.