Guest blog post from McGladrey LLP
The 22.3 percent rise in the value of the real trade-weighted U.S. dollar index during the past few years (half of its rise has occurred in the past eight months) is the result of changing global economic dynamics that aren’t likely to abate anytime soon. The underlying causes of the rapid appreciation of the greenback are linked to evolving energy dynamics, trade, monetary policy and economic expectations about the direction of the U.S. economy relative to rest of the world. The strength of the dollar is not a short term phenomenon. In fact, it is likely to prove to be the defining economic characteristic of the remainder of this decade.
These changes will present near-term challenges for middle market firms (see Currency Volatility May Bring Unwelcome Surprise for Some Firms). Periods of adjustment in global economics always carry asymmetrical distributional costs that are primarily borne by firms with significant exposure to foreign demand. However, over the medium-term a strong dollar will result in cheaper commodities which, complemented by a reduced cost of production associated with lower energy costs and greater purchasing power for U.S. consumers, will result in a stronger U.S. economy.
Middle Market Insight: Given rapidly changing global economic conditions, middle market firms might want to consider approaching the purchase of effective hedges against currency volatility in the same way households purchase auto, homeowners, life or rental insurance. It’s a necessary expense that one pays for with the intent of never having to use it.
Stronger domestic demand in the United States relative to China, the eurozone and Japan on a global basis, as well as its major trading partners, Canada and Mexico, is the major reason why the greenback has soared during the past several months.
In 2014 the U.S. growth rate was 2.5 percent on a year-ago basis, above the long-term trend of 2.1 percent. Compare that with the 0.9 percent rate of growth in the eurozone, a minus 0.5 percent contraction in Japan, 0.7 percent growth in Mexico and 1.9 percent growth through November in Canada, not to mention the rapid slowing of growth in China.
A look forward at expectations for 2015 through 2018 suggests that story isn’t likely to change much. Growth in the United States is expected to be near 2.7 percent versus negligible growth in both the eurozone and Japan. Meanwhile, China will likely slip below the 7 percent growth rate which signals recession in that economy. Canada is expected to see growth around 2.2 percent and Mexico near 3.3 percent during the next two years, but both of those expected growth rates are overly dependent on a rebound in global oil prices. Should oil prices remain below the five-year average of $101.56 and the 10-year average of $86.81, there is a risk of much slower growth among America’s primary trading partners. As a result, there is some risk for even further dollar appreciation.