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May 22, 2018

Why are currencies important to understand?

Historically, the U.S. dollar has been the strongest and safest currency in the world. However, from time to time, due to weak economics or overspending, the dollar can weaken. Interestingly, this is generally good for most investments. Our biggest companies in the United States have become global in nature and earn enormous amounts of money from outside the country. In some cases, major U.S. conglomerates actually collect the majority of their earnings overseas. While that point may seem counterintuitive, a weak U.S. dollar actually makes our products cheaper in other countries, and helps create more demand for our products.

Take an example: Assume that the euro and the U.S. dollar are trading at parity, and an Apple iPhone costs $500 in the United States as well as in Europe. Then, all of a sudden, the dollar weakens and you have the euro trading at 1.20 to every U.S. dollar.

Once that happens, suddenly, the iPhone can be bought by Europeans at roughly $415, taking exchange rates into account. This dollar amount essentially equals a “sale” price, so demand abroad increases, and so do earnings for Apple. U.S. company products are suddenly cheaper and more competitive than other foreign brands.

Additionally, investments may similarly enjoy the benefit of a weaker U.S. currency. Commodities, for example, are priced in U.S. dollars; therefore, as the dollar gets weaker, the prices of these commodities go up. This phenomenon can also dramatically affect the value of your non-U.S. investments. How does that work? The simplest way to understand this is by example:

Let’s say you buy a stock in the UK that is $142 in U.S. terms, and the British pound is 1.42 for every U.S. dollar. Now, let’s say that the dollar weakens after this trade, to 1.45 pounds for every U.S. dollar. When you sell a share, you will now receive $145, therefore making more return without the actual stock price moving up. This will also be true when you buy an international fund.

The same scenario occurs with other global currencies. Even if the stock doesn’t move up, you still can make money, as long the U.S. dollar weakens against the currency your stocks trade in.

There is a gentle balance to this, and extremes can cause major disruptions. But during moderate, or at least measured, fluctuations in currency markets, this pattern will remain. A seasoned investor can use these patterns to his or her advantage—to diversify a portfolio’s holdings, not only in equities, but also in bonds.

Beyond simple investing, a seasoned entrepreneur who understands the patterns of currency movements will have more success operating a business. Consider: In today’s world, businesses have become more global. So, any business that earns money from outside the United States can definitely use currency expertise to help navigate different cycles.

As an example, you have likely heard over the last decade or so that travel to Europe is rather cheap right now, and vice versa. Flights and hotels, in fact, can get a lot less expensive for U.S. clients during periods when the U.S. dollar strengthens, and, therefore, advertising can be directed to the markets that will help keep business flowing.

Companies take advantage of this situation all the time, advertising lower prices for airfare and other items to entice people to travel. So, similarly, the savvier a company is at understanding currency, the more advantages will accrue.

The best advice here is this: Currency matters to investors and businesses alike, and a knowledge of currency movements is a vital talent. Don’t get caught up in the day-to-day currency swings, but do take a longer-term view and plan for where you think currencies can help you in your personal investing or your business. Then watch those advantages accrue.

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