What Makes Currency Strong?

By Claire L. Burgess

Even before the economic downturn took hold, the plummeting value of the dollar had many Americans cutting back—and not just on pricey foreign vacations. The effects of the dollar’s historic decline have been felt in everything from soaring gas prices and higher food costs to fluctuating interest rates and the meltdown on Wall Street.

What’s the big deal? Isn’t a dollar still worth a dollar? Of course—but it’s not necessarily worth a euro or a British pound, or any other foreign currency, says UAB international finance expert Andreas Rauterkus, Ph.D. This difference in value takes a toll on international trade: While American goods become cheaper to consumers from other countries, the foreign goods we buy—everything from Swiss chocolate to new BMWs—are more expensive.

In a perfect world, exchange rates should make the price of products the same in every country. This is called the Purchasing Power Parity (PPP) theory, says Rauterkus. But because the world is “not a laboratory environment,” the theory does not always hold true: Varying taxes, wages, laws, and interest rates make the PPP measure imperfect.
One obvious sign of the weakness of the dollar is soaring oil prices. Transactions in the international oil market are conducted in dollars, which has actually been very beneficial to America, says Rauterkus. But when the dollar’s value slips compared to other currencies, prices have to rise to even out the discrepancy, and Americans end up paying more at the pump.

So how did the dollar drop from the most powerful currency in the world to its current lowly level? One reason is the sheer number of dollars in circulation. “Currency works by supply and demand, just like anything else,” Rauterkus says. “There’s an enormous supply of dollars out there, and if there’s more supply than demand, that’s going to make the currency value drop.”

Another factor holding the dollar down is the national debt, which keeps increasing every year. There is no way for the dollar to increase in value until the economy stabilizes, Rauterkus says, and the economy cannot get back on track until the deficit decreases. “When the economy gets stronger,” he notes, “the dollar is going to get stronger.”

For those who still want to head overseas, Rauterkus suggests traveling to countries where the cost of living is low, such as Mexico and much of South America. “You don’t want to go to Europe right now,” he says. “It’s always expensive, but with the current exchange rate, it’s a killer.” Nevertheless, Rauterkus predicts a change in our financial fortunes.

"The euro, I believe, is overvalued,” he says. “The dollar is going to be stronger in the long run.”