A Strong Dollar Should Not Attract Foreign Investment--Expectations of a Stronger Dollar Should

Commentary by Bob McTeer

Source: Forbes

Whether the dollar is strong or weak matters for our exports and imports because their prices change in foreign currencies. Many people on the financial news networks appear to believe that similar reasoning applies to capital flows, i.e., that a strong dollar attracts foreign capital. Not so!

Think about it. If a foreigner wants to invest in U.S. assets, the dollar could be strong or weak, but as long as it remains that strong or that weak, the foreign investor can get out of dollars at the same price he got in. No matter how strong or how weak the dollar!

On the other hand, the foreign investor would like to see the dollar strengthen during his investment period. Then he could move back into his local currency at a more favorable (profitable) rate. What he doesn’t want is for the dollar to weaken during his investment period. That would subtract from what he earned when he takes his earnings back home. It doesn’t matter if the dollar is strong or weak, as long as it stays that way.

What does matter is whether the dollar strengthens or weakens during the investment period. A strengthening would add to his investment earnings; a weakening would subtract.

(By the way, the same logic applies if the investor is a she rather than a he.)

So, while the level of the dollar shouldn’t matter to the investor, expectations of movements in the dollar during the investment period do matter. The investor benefits from appreciation and suffers from depreciation during the investment period.

So, should a strong dollar attract foreign investment? No, but expectations of an even stronger dollar should. The important question is when does a strengthening of the dollar generate expectations of further appreciation and when does the appreciation go so far as to generate expectations of a reversal. When the consensus shifts to the view that the dollar has risen so far that a near-term decline is inevitable, the strong dollar with repel rather than attract capital.

(Forgive me, but I’m vaguely reminded of a lecture in a freshman philosophy class. When some things happen, it increases the probability of it happening again. I think the example was the sun rising in the morning. On the other hand, when some things happen, it reduces the probability of it happening again. I think the example was an empty chamber in a game of Russian roulette. Which category does the stronger dollar fall into?)