Strong US Dollar Rouses Optimism

Douglas Johnson on how a shift in the US economy is good news for many others as well.


Rashid looked at me pointedly and declared, “Stocks are like a casino. Why do you bother with them? I only invest in hotels.” I suggested that other investors view equities as a wealth engine and that he should be more magnanimous. Rashid was not convinced.


Many choose to avoid stocks, but everyone should pay attention to stock markets. The logic is simple. Equities are the most sensitive indicator known to measure future economic potential. And right now, by that measure, we are in trouble. Major markets as a group were down almost 3% in US dollar terms last year, with steep declines in the early weeks of 2016. Emerging markets delivered returns that were far worse. Investors in Nigerian stocks, as one example, saw US dollar-based losses of more than 20% in the first half of January. The collapse in Lagos—and elsewhere—can be attributed to the faltering oil price.


So how to salvage the global economy? US growth is respectable, but it is not strong enough to be a growth engine. The Chinese economy is mired in upheaval. European activity is still bottoming. More generally, central banks have very little gunpowder left; governments have no fiscal wherewithal so soon after the credit crisis. Meanwhile, frustration with the growth setting is crystalizing into political unrest. Just look at the vitriol surrounding the current refugee debate in Europe.


A strong US dollar rouses optimism, in my view. The relative buoyancy of the American economy may be one cause, while a flight to safety by global investors may be another.


I see five reasons why continued strength in the US dollar may be an important catalyst for better global economic momentum, in the absence of alternatives. The overriding theme is transfer of activity from the dollar-based world. None of these points will play out decisively over the next couple of months. But farther afield—assuming we can avoid a systemic breakdown—these developments may propel the global economy toward more conclusive growth.


1. Strong Dollar Translates into Weak Euro

There is economic heft percolating in Europe. A weak euro will likely support sales momentum for European companies in those distant economies where growth is evident. For context, exports of goods and services for the European union as a whole is about 26% of GDP (excluding intra-European data). That is roughly twice the impact of exports on the US economy. German and French goods, among others, are now dramatically more competitive internationally than they were a few years ago.


Better growth in Europe will in turn have a positive impact on North Africa. The Maghreb nations and Egypt are heavily dependent on trans-Mediterranean ties. There is the obvious role of the tourism sector. But fewer observers appreciate the growing scope of North Africa-based manufacturing. Morocco, for instance, is coming into its own with automobile assembly.


2. Strong Dollar Bolsters Outbound Investment

Companies based in the US and others with dollar-based earnings now have an incentive to accelerate their foreign direct investment activity. Foxconn, the Taiwan-based electronics manufacturer, recently announced a $5 billion commitment to India. Reasons include lower cost of labor and closer access to a key market.


A single investment by one company is not going to lead to a resurgence of growth in the developing world. But it may be easier to understand the impact of foreign direct investment if you consider the countless opportunities that drive global business. Government policies also play a role here. One example is China’s move to shorten the workout period for bankrupt companies. Investors are more attracted to a market if they know they can exit easily when strategic plans go awry.


3. Strong Dollar Offers Remittance Impact

International migrants traditionally send earnings to their families in their home nations. Yet remittances are the underbelly of cross-border capital flows. They are poorly understood and difficult to track. When a strong dollar inflates the local-currency value of inbound remittances, the impact on destination economies can be meaningful. Not all international migrants are laborers; many are professional-class workers supporting middle-income families in their home nation.


The World Bank has done an admirable job of trying to understand remittance trends, but quantifying millions of small transactions that pass through diverse financial intermediaries is tough going. One obvious benefit is that that inbound remittances support consumption in the recipient nation. This sort of regular cash infusion is usually allocated to household expenditures. But savings over time can lead to surprising developments, including spikes in discretionary spending. Large developing countries that benefit from these flows include India and China, as well as Mexico, the Philippines, and Egypt.


4. Strong Dollar Supports Lower Energy Costs

A strong dollar traditionally drives down the oil price because of weaker demand in non-dollar economies. But added factors are at play in the current oil-price collapse. The sharply lower oil price is a gift to oil-importing countries such as China and India, both of which have the potential to drive global growth. China imports some 6.1 million barrels of oil per day to meet its oil requirement, while India imports about 2.7 million to meet its demand, according to latest information from the US Energy Information Agency. The energy-based savings in these countries improves profit margins in the private sector or offers the ability for incremental fiscal stimulus in the public sector.


The flip side of that argument is a painful restructuring process in oil-exporting economies. As state patronage dissipates, the economies of the Middle East, among others, are deeply committed to industrial diversification. That is creating a worthwhile playing field in fast-growing sectors such as technology and renewable energy. Investors based in these markets may want to consider the opportunities that structural realignment is generating for them. Those investors become the “smart money” that international names may follow over time.


5. Strong Dollar Limits Interest-Rate Upside

The most immediate impact of a strong US dollar is that it should restrain future interest-rate increases by the Federal Reserve. One reason is that the currency mitigates upward price increases by keeping import costs lower than would otherwise be the case. Still another point is that a strong currency may negatively impact the job market as companies lose international sales or shift production offshore to cut expenses. Any policy move amid that scenario might exacerbate latent economic weakness.


The strong dollar, as an antidote to higher interest rates, offers behavioral relief. It helps investors to appreciate that capital-market volatility may be limited because other central banks—especially those in the developing world—can keep their rates steady. Those authorities will not have to follow in the footsteps of the Federal Reserve to keep policy-rate spreads in relative equilibrium.


The strong dollar may be the best weapon in our artillery at this point. One obvious counterpoint is the ability of companies to service dollar-denominated debt when their revenue streams may be in local currencies. Yet echoes of the Asian currency crisis that began in 1997 may be over-amplified. A second is the potential for competitive devaluation as countries vie with each other for narrow export potential. Those issues could upend a delicate global balance and are likely to remain in place until we achieve a more certain economic trajectory. Policymakers need to remain vigilant.


Perhaps 2016 can be labelled the “Year of the Investor versus the Economist.” Those with portfolio management responsibilities have the luxury of identifying forward-looking allocation scenarios to meet return expectations. Playing into the transfer of activity provoked by the strong dollar seems like a reasonable place to start. Economists help us by painting a backdrop for that decision-making process.


Investors should have a lively year ahead, despite the gloom heralded by some economists. Any incremental volatility creates further opportunities, particularly when asset values are as depressed as they are at this time. Those fortunate enough to have cash at hand may benefit by remembering that cross-border can be risk-averse. One idea: Keep an eye on sovereign wealth funds. In the absence of liability-matching constraints, many of those institutions are looking to increase their risk exposure. Their conservative, if not defensive, public stance may be a touch of misinformation.


Back to Rashid. When we spoke at the start of this year, he mentioned that he is looking at fintech in Asia and agribusiness in South America. He is still not interested in stocks, but the return potential that he may realize in some of those offshore direct investments is enhanced by a now-lower cash requirement. He was encouraged by finding “deep value.”


Rashid offers us an asset-management lesson at this point in the investment cycle: Being savvy may be better aligned with market reality, than staying scared.


About Douglas Johnson

Douglas Johnson is the Managing Director of Miami-based Cranganore Inc. His firm serves investors and entrepreneurs worldwide, with a focus on the emerging markets. His professional experience includes work as investment banker, fund manager, and portfolio strategist. Readers can subscribe to his daily bulletin at





Your email address will not be published. Required fields are marked *