If you're a U.S. investor primarily in U.S. stocks, chances are you don't think too much about how the greenback is faring vs. other currencies. There hasn't been much reason to. Since the late 1980s, the dollar has strengthened against most currencies as foreigners have been more than happy to hold dollar-denominated assets. They have been doubly rewarded -- once by the rising dollar and a second time by higher stock prices.
Foreign confidence in the dollar has benefited U.S. investors, too. Think of overseas inflows as a kind of rising tide of money that has helped lift all boats.
Today was no different. As the dollar reached a new all-time high against the euro and held steady vs. the strong Japanese yen, stocks rallied.
"I come in every day amazed by the strength of the dollar, and then I go about my business of buying stocks," said Michael Harkins of the hedge fund
. "What else is there to do? Every time the dollar makes a new high against the euro, I get more long stocks."
Harkins used to worry that the dollar would collapse because of the huge and growing trade deficit the U.S. runs with the rest of the world. (The
current account deficit now towers at about 3.6% of
gross domestic product and grows larger by the month.) If foreigners fled the dollar, he feared, they would also crush the stock market. But the dollar has defied the skeptics for years.
So Harkins hardly worries about the dollar these days. "As long as foreigners are happily taking dollars, the trade deficit is not a problem," he said.
Currency strategist Tim Fox of
Standard Chartered Bank
sees only one scenario that could make foreigners flee the dollar: If they were to see the
Federal Reserve as very much behind the curve in the battle against inflation.
To send our overseas friends scampering for the exits, "there would have to be a crisis of confidence about the U.S. economy overheating and the Fed being way late to raise interest rates," said Fox. If the Fed were late, his reasoning goes, it would have to raise rates so fast and hard that economic growth would be choked and with it corporate profits. In such a moment of higher inflation and interest rates, investors would likely dump U.S. stocks and bonds.
The panic scenario is generally considered unlikely. "Most people now see the Fed as raising rates pre-emptively," said Fox. "Economic fundamentals in the U.S. remain strong."
He is less worried about today's trade deficit than the ones of the late 1980's. "In the '80s, the deficit was seen as a reflection of the inability of U.S. companies to compete globally," Fox said. "Today the view is more that the deficit reflects strong U.S. demand rather than a lack of competitiveness."
Foreigners also take heart from Washington's strong-dollar policy. Under
made it clear to the markets that the U.S. government would not allow the dollar to slide as a way to stimulate exports and thus narrow the trade deficit. Rubin's successor, Treasury Secretary
, continues that policy.
senior managing director David Malpass sees little likelihood of a run on the dollar. "The sky-is-falling crew has been consistently wrong on the dollar for years," he said. "Trade deficits are not necessarily bad for a currency. What matters more is sound government policy, economic growth and reasonably high interest rates. We have all of those today."
Damon Mezzacappa, a former
partner who now runs the
fund of funds, agrees: "If offshore investors have confidence in the strength of our economy, in our political system and in the viability of our financial markets," he said, "they will continue to want to own dollar-denominated securities."
But if the day should ever come -- and it might -- when the currency backdrop changes, understanding what the strong dollar has meant to the stock market will come in awfully handy.