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For years, it has been a common soundbite to hear politicians, government officials, and some economists talk about the importance of maintaining a strong U.S. dollar. The concept of a “strong dollar policy” originated with Treasury Secretary Robert Rubin in early 1995 and has been echoed by many Treasury Secretaries since.

One Dollar

The thinking goes that a strong dollar helps keep U.S. inflation low, encourages foreign investment, and helps the dollar maintain its status as the world’s reserve currency.

Those who believe in this policy should be very happy as the dollar is currently trading near a 13-year high. So that’s good, right?

Not exactly.

Although there are some benefits to a stronger dollar, the current strength has had an adverse effect on the earnings of U.S. companies. Companies in the S&P 500 Index are truly global in terms of sales and operations – approximately 50% of revenue earned by companies in the S&P 500 is earned overseas. A stronger dollar makes U.S.-made products more expensive to non-U.S. consumers, which can reduce global sales.

In addition, earnings from the foreign operations of U.S. companies need to be translated back to U.S. dollars for accounting purposes. When McDonald’s sells a Le Big Mac in France, they are paid in euros and those euros are translated into U.S. dollars for accounting purposes. When the dollar strengthens, each Big Mac sold in France earns McDonald’s fewer dollars.

The strong dollar is one reason that S&P 500 earnings growth has been negative for three consecutive quarters. Another reason is the poor earnings of energy companies, which brings us to another common soundbite that could be questioned in the current environment: Low energy prices are good for the economy.

This concept has been around even longer than the strong dollar policy and it has not been uncommon to hear a politician cite the high price of oil as a failure of a President’s policies.

The thinking behind this is very straightforward. Low energy prices equate to low inflation and less money spent at the gas pump or heating your home.

And again, those who espouse this thinking should be very happy as the price of oil hit a 13-year low in February of this year. That also sounds pretty good, right?

Low oil prices are good for the economy only as long as they don’t get too low. Oil prices have dropped approximately 65% since June of 2014 and have reached a level where the cost of producing oil in North America is higher than the sales price per barrel. This has led to extremely poor earnings for energy companies which, in turn, have led to layoffs and a spike in debt defaults. The spike in debt defaults led to concerns about banks that issued loans to energy companies. This is one reason the U.S. stock market declined sharply at the beginning of the year.

Issues like U.S. dollar strength and the price of oil are significantly more complicated than some politicians and pundits would have you believe. As the old adage goes, be careful what you wish for because it just might come true.

Various sources: J.P. Morgan, U.S, Energy Information Administration (EIA), Wall Street Journal

Filed under: Investing

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