A Strong Dollar and Richard Nixon

You’re probably wondering what connects the two. Since the financial media news is so busy talking about the strong dollar, we thought it might be interesting to go back in history and look at the evolution of the dollar.

Up until the Bretton Woods agreement of 1971, the US dollar was tied to the gold standard, which means the US government promised to other central banks that it would redeem their dollars for gold at the fixed rate of $35 an ounce.  To make international trade easy, a lot of countries chose to align their currencies with the US dollar. This is one of the reasons that the US dollar is the reserve currency of the world.

All was well until the US government ran up large deficits to pay for the Vietnam War AND French President Charles DeGaulle starting selling France’s dollars and converting them to gold. This put enormous stress on the fixed rate exchange of $35 and the international trade exchanges. If the US abandoned the gold standard, the dollar would certainly drop in value. What to do? How could the Nixon administration create demand (therefore stabilizing the price) for US dollars?

Enter Saudi Arabia and Henry Kissinger. In the late 60’s Saudi Arabia’s oil fields were vulnerable to attack and Saudi did not have the ability to defend itself.  Henry Kissinger struck a deal with the Saudi’s that continues to last through today. In exchange for US weapons and protection, all Saudi oil sales would be priced in US dollars. Saudi leaned on other OPEC nations to follow suit. This created the demand for US dollars that was needed to support the dollar during the move from the gold standard. All countries need oil. Oil (and other commodities for that matter) are priced in US dollars. And that is the story of the US Dollar as the world’s reserve currency.

What does a strong dollar mean for markets and investment portfolios?  A strong dollar makes it more expensive for other countries to import our products. With 50% of the S&P 500 earnings coming from overseas, companies such as Coke, Pepsi, Proctor and Gamble, GE and other large multi-nationals have unfavorable currency exchanges thus lowering earnings. While some of this currency risk can be hedged, not all of it can. Also, with the dollar so strong many foreign companies cannot afford to import goods putting a crimp on sales. From our perspective, this leaves sectors such as consumer discretionary, consumer staples and export focused industrials unattractive.  With oil and other commodities still unstable in price, energy is not quite attractive yet. Healthcare and Asian equities are sectors where demand continues to be strong and valuations are reasonable.

While we don’t know where the market will go, we know that we are diligent in our monitoring and analysis of the trends we see.