If you've been managing your finances for any length of time, you probably understand the value of a dollar. However, you may be less informed as to what it means when the U.S. dollar is strong vs. weak.
These terms are used to describe the relative strength of the dollar against other foreign currencies at any given time. Where the dollar falls on this scale can have a direct influence on your purchasing power and how far your budget can stretch.
It's important to know what a weak dollar could mean for the economy at large—and on a smaller scale, your individual financial plan.
What Is a Weak Dollar?
A weak dollar simply means that the value of a dollar, in terms of the number of goods and services it can buy, is decreasing relative to the value of one or more foreign currencies. Factors that can contribute to a weak dollar include:
- Supply and demand for exported and imported goods and services
- Overall market sentiment
- Tax policy and tax reform
- Foreign trade policy
- Interest rate policy
- Gross domestic product forecasts
- Unemployment rates
- Acceleration or deceleration of domestic economic growth
- Market fluctuations, trade regulations, and economic growth in foreign countries
All of these factors are connected and interact with one another in different ways to influence the relative strength or weakness of the dollar.
When stocks soar, and unemployment remains low, for instance, the dollar can rise. The opposite effect may result if the market plunges or if joblessness increases.
Is a Weak Dollar Good or Bad?
A weak dollar can have marked economic effects. For example, if one of the U.S.'s trade partners is experiencing its own weak currency cycle, that can result in lower prices for the goods that the country produces. The side effect is that it becomes more difficult for domestic manufacturers to compete with those reduced prices.
If a foreign country's currency remains strong while the dollar falters, that can result in higher prices for imported goods. Those higher prices are then passed on to consumers. Likewise, traveling to foreign countries may become more expensive, as a weak dollar might not be able to stretch as far overseas.
There is an advantage for the economy as a whole, however, when the dollar is weak. Items exported from the U.S. become cheaper, making it easier for companies that sell overseas to remain competitive in the marketplace.
In fact, some countries may intentionally devalue their currency to make themselves more competitive economically, particularly following a downturn or recession.
What a Weak Dollar Means for Consumers
Economic concerns aside, you may be more focused on how a weak dollar could translate to your ability to buy the things you need and want. Items that tend to be more susceptible to the impacts of a weak dollar include commodities, gasoline, and travel. It can also affect products manufactured from imported goods.
Assume, for instance, that the dollar loses 10% of its value. At the same time, gas and food prices rise by 10%, thanks to inflation. Between the two, a weak dollar means that your money now has to work 20% harder to buy the same amount of food or gas. The imported items that are most likely to see prices influenced by a weak dollar include:
- Vehicles (including steel, rubber tires, and other components)
- Computers and electronics
- Furniture, lighting, and bedding
- Plastics and plastic goods
- Oil and other petroleum products
- Coffee, sugar, and tea
- Wheat and corn
As you can see, the list of imports—and the resulting effects of a weak dollar—can touch virtually every aspect of your daily life. It's also worth noting that a weak dollar could affect your investments if you own stocks in companies that are sensitive to dollar value movements. That's particularly important if you're nearing retirement and transitioning from the accumulation phase to the spending phase. When a weak dollar is paired with rising inflation, your purchasing power could be eroded even further.
How to Combat a Weak Dollar
While there's nothing consumers can do to directly influence the strength or weakness of the dollar, there are some remedies for downplaying its financial impacts.
First, consider increasing savings to take advantage of a rising rate environment. A high-yield savings account or CD account may be a safe and attractive choice for growing cash savings when rates climb.
Next, revisit your budget and spending. Focus on reducing or eliminating non-essential spending, or spending on items that may see an increase in prices driven by a weak dollar. If you're planning any foreign vacations, consider currency values overseas to determine where your dollars would stretch the furthest.
Finally, insulate your investment portfolio against a weakening dollar with real estate and other tangible assets that tend to hold up well even when currency loses value. You may also consider investing in strong foreign currency ETFs or foreign- and U.S.-based companies that generate most or all of their revenue outside the U.S.
These strategies can help in maintaining consistent returns in the short term, and potentially the long term, as currency values shift.