It was good to have summer over and see Texas Lutheran University’s campus filled with lots of bright, inquisitive kids.
No sooner had class started than a hand shot up in the back of the room. Louie read my article on the devaluation of the dollar last month but remained confused.
He explained that although my article discussed how the dollar is losing its value, the current news keeps referring to a “strong dollar.”
His question was a good one. How can the dollar be “strong” when others keep complaining it is weak?
As I referenced my previous article, the U.S. dollar’s purchasing power has devalued about 95 percent over the past 100 years. However, it is a relative game since there are many currencies in the world all trading against each other in the world markets.
Another hand shot up. Hannah asked how the strong dollar affected the portfolio the students manage.
She recalled in the fourth quarter of 2014 that Coca-Cola’s reported earnings declined year over year. However, on a constant currency basis, earnings were actually up 7 percent.
How could Coke report earnings that are both up and down at the same time?
Each day, Coke sells its products in more than 200 counties. And although Coke reports earnings in U.S. dollars, it is not paid in dollars from all customers.
Since all currencies fluctuate in value relative to one another, at the end of the year, multi-national companies such as Coke must settle their books to report their financial results in one currency. Coca-Cola, being domiciled in the U.S., reports official earnings in dollars.
As Zoey analyzed Coke’s financial statements she observed that although the drink company reported a decline in year over year earnings, they actually sold more soda water.
Samantha found an article that stated the Federal Reserve’s dollar index, that tracks our currency against the currencies of 26 U.S. trading partners, has increased 18 percent since the end of 2013. It is now near its record high set in February 2002. If it continues on this trajectory, the dollar will have its steepest two-year advance since 1984.
Kirby wanted to know what other implications there are to a strong dollar.
A stout dollar means goods and services produced in other countries are, on average, cheaper for Americans to buy. Additionally, it is a great time to travel internationally as the dollar stretches purchasing power in foreign nations.
Zoey wanted to know whether there were downsides to a strong dollar.
It brought up a good point as relative strength in currency is not an “all good” or “all bad” situation, but rather a bit of both.
We discussed that a strong dollar indicates it can be more expensive for U.S.-based manufacturers to compete on a worldwide basis and export their goods and services. It also makes it more expensive for foreign companies to invest in factories and operations on U.S. soil.
A strong dollar can also limit decisions on behalf of the Federal Reserve. If the Fed had increased interest rates at their recent meeting that move in turn increases the value of the dollar relative to other currencies. At a time when the dollar is already quite strong, it may have given the Fed reason to pause.
Finally, the students sought guidance on how to view their portfolio given these fluctuations in currency.
We know different currencies may change how you account for things, but currency itself is not a driver of value. Currency is simply an accounting metric.
Additionally, currencies always move relative to each other and it is impossible to know which ones will do better. Although the dollar is strong now, it will not always be that way. We would rather own multi-national investments selling good products or services around the world. By getting paid in a variety of currencies, it tends to smooth out some of the bigger swings that can occur.
Furthermore, it is far more important to evaluate investment opportunities on a “constant currency” basis. This allows investors to focus on operational efficiency, which is typically a better long-term driver of value than currency.
Although it’s interesting to discuss, it’s not necessary to have a Ph.D.-level understanding of currency markets to buy good businesses. And it certainly makes it a whole lot easier to sleep at night.
Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other week.