The US currency is the world's reserve currency and the one that most influences the markets for commodities such as wheat, oil, and gold. What happens when the dollar rises or falls against other international currencies? Inflation and growth are where the effects are seen.
The role of the dollar in the global economy
The American currency is the main reserve currency of the world. This means that central banks of all countries, governments and companies have large amounts of dollars for one main reason: this is the currency used for trading.
When a country buys oil or gold, or when companies from different continents interact, payments are usually made in US dollars. Such is its importance and relevance that more than half of the reserves held by central banks are in dollars. Tons of green bills stacked up.
These data make it easier to understand that the impact of dollar fluctuations is significant across all economies. If we add to this that their movements tend to be quite cyclical, then it is more important take into account how their strength or weakness influences raw materials, which are a fundamental pillar for economies around the world.
What is the dollar cycle?
Over the past few years, the dollar has gone through periods of strength and weakness. However, despite the talk of a cycle, there is no exact time-based measurement of how often a dollar might become stronger or weaker. This is determined by macroeconomic conditions and the monetary decisions made by the Federal Reserve.
A strong dollar is one that appreciates against other currencies such as the euro, the yen, the yuan or the Swiss franc. This, in turn, is a consequence of the fact that the US U.S. grows more solidly than the rest of the economies when the Federal Reserve (Fed) raises interest rates or when there is global uncertainty and investors protect themselves by buying dollars. Not all circumstances need to be met; sometimes it occurs with only one of them.
On the other hand, when the dollar weakens, it means that it is worth less against other currencies such as those mentioned above. It usually occurs when the Fed lowers interest rates or implements a more expansionary monetary policy; when there is economic recovery in economies other than the US economy — for example, Europe or emerging economies grow more —; or, finally, when investors look for assets that they consider more profitable.
How does the dollar cycle impact commodities?
Once you understand the importance of the dollar in the global economy and the cycles it typically goes through, it's easier to identify how it interacts with commodities like oil or gold.
Generally, when the dollar is strong and rises against other international currencies, the price of raw materials becomes more expensive in other currencies. For example, if the dollar rises from 1.14 to 1.04 euros, a European investor previously exchanged 1,000 euros for 1,140 dollars, while after the increase, they exchange 1,000 euros for 1,040 dollars. This means that, with the same amount of money, you can buy less oil, gold, wheat or any other raw material.
In turn, emerging economies, which are more sensitive, tend to suffer more with a strong dollar because it takes more effort for them to buy raw materials. For example, in this case, India or China must allocate a greater amount of money to buy crude oil.
Conversely, when the dollar weakens, other countries can purchase more raw materials with the same amount of money. Although it's also possible that the price could rise or remain stable in dollar terms, as demand could increase due to lower prices.
The most common thing is that, with the weak dollar, countries that produce raw materials can sell more because the dollar is “cheap”, which boosts their economies. At the same time, inflation in countries that don't use dollars may fall, as they need less money to buy oil or other raw materials.
In short, a strong dollar can mean a restriction of demand for raw materials, a possible increase in inflation and greater difficulties for emerging economies. While a weak dollar can accelerate demand for commodities, reduce inflation, and boost developing economies, especially those that export raw materials.
What happens if you already have investments and the dollar rises or falls?
Many investors incorporate gold into their portfolios. This asset, being a raw material, is denominated in dollars and is greatly affected by currency fluctuations. Therefore, it is important to consider what happens to gold when the dollar rises or falls.
If you hold a currency like the euro and the dollar weakens, your profitability on dollar-denominated assets is negatively affected. On the other hand, if the dollar strengthens, profitability improves. However, you should keep in mind that, over the long term, the dollar cycle does not typically have a significant impact on profitability. In short periods, however, it can have a considerable influence.