What it means
The dollar's strength is judged against other currencies, either one at a time or through an index that tracks it against a basket. When the dollar weakens, it takes more dollars to buy the same amount of euros, pounds or yen.
Interest rate changes, inflation, economic growth and global investor sentiment all influence the trend. Exporters are the clearest winners.
A US machinery maker that prices in dollars becomes cheaper to a European buyer, who needs fewer euros to pay the same invoice. Companies that sell abroad in local currency also gain, because those foreign sales convert into more dollars.
Large multinationals feel the effect in their reported results. A company with substantial overseas revenue sees its earnings rise in dollar terms when it translates foreign profit back into dollars, even if sales volumes are unchanged.
Analysts often separate this currency effect from underlying growth when they discuss results. On the other side, American consumers and businesses that buy imports pay more.
Fuel, electronics, and travel abroad all cost more in dollars. Many commodities, such as oil and gold, are priced in dollars, and their prices in other currencies often move in the opposite direction to the dollar.
Tourism is another channel worth noting. A cheaper dollar makes the US a bargain for overseas visitors, which can lift hotel, retail and airline revenue in American cities.
The nuance is that a weak dollar affects different groups unevenly. It helps manufacturers and exporters but hurts importers, retailers with foreign suppliers and travellers.
It is also not a verdict on the health of the economy, because policymakers sometimes accept a weaker currency to support growth and exports.
In practice
Real-world examples.
Example
A US furniture maker sells to retailers in Germany and prices its goods in dollars. When the dollar weakens, the German retailers need fewer euros to pay each invoice. Orders rise because the products now look cheaper than local alternatives, and the sales director plans to add two more European distributors.
Example
A US toy company buys most of its products from suppliers in Asia, paying in local currencies. As the dollar weakens, the supplier invoices cost more dollars. The buyer negotiates longer contracts to fix the price and considers raising shelf prices by a few per cent if the trend continues.
Example
An American family plans a holiday in Europe. With a weaker dollar, hotel and restaurant bills are noticeably higher in dollar terms. They shorten the trip by two days to stay within their $6,000 budget.
Formula
Calculation
Dollar value of foreign revenue = Foreign currency revenue x Exchange rate (dollars per unit of foreign currency)
Suppose a US company earns 10,000,000 euros in Europe in a year. When the exchange rate is $1.10 per euro, the revenue is worth 10,000,000 x 1.10 = $11,000,000. After the dollar weakens, the rate becomes $1.20 per euro, and the same revenue is worth 10,000,000 x 1.20 = $12,000,000. The company reports an extra 12,000,000 - 11,000,000 = $1,000,000, an increase of 1,000,000 / 11,000,000 = 9.1%, without selling a single extra unit.Case study
Seen in the real world.
Bridgeport Components is an illustrative, fictional US manufacturer of industrial sensors, with 40% of its sales in Europe and Asia. In a year when the dollar weakened by about 10%, its sales in local currency stayed flat.
When the finance team translated the foreign revenue into dollars, reported sales rose by roughly 4%, because 40% of sales rose by 10%. The CFO told the board that this growth came from currency and not from selling more products.
In this illustrative story the team also noticed that the cost of imported parts had increased, which partly offset the gain. The lesson is that a weak dollar affects revenue and costs differently, and results should be analysed with the currency effect shown separately so that the board sees the true picture of performance.
Watch out
Common mistakes.
- Treating a weak dollar as good news for every US company, when importers and businesses with foreign suppliers face higher costs.
- Counting currency-driven revenue growth as real sales growth, when no extra products were sold.
- Assuming a weak dollar always signals a weak economy, when it can result from policy choices or a stronger recovery abroad.
Questions
People also ask.
Why do commodity prices often rise when the dollar weakens?
Many commodities are priced in dollars, so buyers using other currencies find them cheaper, which can raise demand and prices.
How do companies protect themselves from dollar swings?
They use hedging contracts, which fix an exchange rate for a future date, set prices in several currencies and match costs with revenues in the same currency so that gains and losses offset each other.
Does a weak dollar cause inflation?
It can add to inflation by raising the cost of imports, but the size of the effect depends on how much the economy imports, how quickly businesses pass costs on, and what else is happening to wages and demand.
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