The dollar is smiling. Not literally. But its value has reached its highest point since the early 2000s.
The increase fits into a theory known as the dollar smile. It says the dollar typically gets stronger when the U.S. economy is healthy, like when it saw a period of economic growth in 2014. Or when the global economy faces unexpected shocks, like we're seeing in 2022. But it loses value when the U.S. economy is on a downward trend compared to the rest of the world, like in 2008 during the Great Recession. That's how the dollar smiles. The dollar is reaching multi-decade highs, and that's because we have the Fed that's in the middle of hiking rates.
We also have people that are very worried about the state of economy. I mean, normally this kind of increase comes like over time, over two, three years. So this is an unexpected surge higher. While a strong dollar might seem like something to be happy about, its impact across the world can be more complicated.
Here's how the dollar starts to smile and the unexpected consequences it can have for the global economy. Let's look back at that smile. One of the main reasons the dollar remains attractive to investors at both ends of the economic spectrum is because it is a dominant global reserve currency, which means every country keeps a certain amount of U.S. dollars in their central banks.
For foreign economies, the wide use of the dollar allows borrowers to have access to a broad pool of lenders and investors. According to the International Monetary Fund, nearly $7 trillion U.S. dollars are held by 149 countries. Investors like the dollar because it's stable. They know that you have a country where there's a central bank that has stepped in to shore up markets and intervenes in the economy at whatever cost to make sure it doesn't crash.
Because so many countries rely on the dollar for trade and various transactions. That means there's always demand for it, which makes it more valuable. But that demand fluctuates and depends largely on the state of the U.S. economy. When the economy is healthy, investors bet on economic growth that will lead to eventual interest rate increases. The theory dubs this end greed mode.
If you're buying currencies, you want to hold the one that's going to give you a higher rate of return. That's linked to your central bank's rate. On the other end of the smile, when the economy is struggling, Investors can flee to the dollar as a more secure asset. That's fear mode, the end we're at now.
The dollar has benefited from basically a confluence of events. Volatile financial markets, fears around growth in the global economy, supply chain issues stemming from the fact that China is still dealing with COVID, and we have a war in Europe that's spurring an energy crisis there, and we have global inflation. So all of that combined has people basically jumping into the U.S. dollar as a haven. A haven is an asset that can retain or even increase its value during an economic downturn.
The dollar's strength is determined by measuring it against other global currencies. When it gets stronger, other currencies grow weaker by comparison. In July, the dollar and euro reached parity for the first time in 20 years.
And as the value of other currencies fall, the impact of the strong dollar ripples through the global economy. The dollar is the main currency used in global trade. That means that things like food and energy are usually priced in dollars when they're bought and sold among certain countries, even if they aren't buying from the U.S. So basically their currency is weakened, which makes everything more expensive for them, which means price increases, which is inflation.
So you're basically, there's this concept that a stronger dollar exports inflation to emerging market countries. But a strong dollar can actually have the opposite effect for Americans. by helping bring prices down.
Strong dollar benefits you because it makes importing goods and services cheaper. People like that. It makes traveling abroad for Americans cheaper. That's also a good thing. But as imports get cheaper for the U.S., exports get more expensive for other countries.
U.S. products become less affordable and therefore less attractive to consumers and businesses abroad. That means that U.S. companies that make a significant portion of their profits overseas can see a decline in sales. Companies have already taken a hit this year. Microsoft, Salesforce, and Coca-Cola are just a few that have pointed out the negative impact of the strong dollar on their financial results.
Here's Microsoft's chief marketing officer after the company filed an 8K, which is a form that reports unexpected changes to shareholders. Say, you know, if you saw the 8K today, it was purely for currency fluctuation. Continued strength of the dollar, essentially, is what we talked about in that. filing.
About 40 percent of S&P 500 companies revenue comes from outside the U.S. and a decline in sales and future earnings tends to make stocks fall. But these lower earnings and reduced import costs can also help curb inflation by bringing prices down and forcing companies to slow spending. You're cooling things down when you have a stronger currency very indirectly.
So some analysts will say it's almost the equivalent of a rate hike. So it's kind of tricky. It's good.
But when it gets too strong, it can start being damaging. Experts expect the dollar to stabilize later this year, but it's unclear when that might be. What you would need for the dollar to stabilize is inflation data to cool.
You would need geopolitical uncertainty to fade. And you'd need a greater belief that the global economy is back on track and that growth is going to return and that financial markets are going to calm down. When the global economy starts to settle, the dollar will likely stop smiling.