How A Too-Strong Dollar Might Lead To A Too-Weak World

It's flattering to be King of the Hill.

And these days, the U.S. dollar is wearing the crown. It has climbed to its highest point in 11 years, with global investors pushing it ahead of the euro and other major currencies.

But while it's a compliment to have a strong dollar, the honor is not without its downsides. When the dollar rises against other currencies, it increases risks to U.S. manufacturers.

So economists are looking for signs that a good thing may be starting to go too far. These questions and answers may help explain what's happening.

First, has the dollar really moved that much?

Yes, the WSJ Dollar Index, which tracks the dollar's performance against 16 other currencies, had a 12 percent rally in 2014. In these early days of the new year, the dollar has been continuing to rise.

Why is this happening?

Currency traders are betting the U.S. economy will be growing so quickly in 2015 that the Federal Reserve will nudge up interest rates from recent historic lows.

The opposite is likely to happen in Europe. There, growth is weak and Greece's political troubles are creating uncertainties.

So if you were a saver, where would you put your money — in a strong, stable country offering rising interest payouts, or in a region with a shaky economic outlook and falling interest rates? Common sense says more people will turn to the United States as a safe haven.

"As dollar assets become more attractive, more money comes into the U.S., pushing up the value of the dollar," said Nariman Behravesh, chief economist for IHS Global Insight. "And as more money leaves Europe, it pushes down the value of the euro."

So what's wrong with having people love the United States?

It is good to have everyone wanting to stash their savings in the United States. But investors' embrace of the dollar can start to feel like a death grip if it goes too far. Here's why:

U.S. companies that make goods and equipment want to compete on a global stage. If the dollar gets too expensive, U.S. exports can get priced out of the market. For example, if a customer in Brazil wants to purchase an earth mover, it could buy one from Caterpillar, or it could turn to companies in Germany or Japan.

If the dollar's value is very high, then it could tip the Brazilian's decision in favor of the Germans or Japanese.

It's not just U.S. manufacturers who worry about the rising dollar. The U.S. tourist industry also could take a hit if Germans, Brits and others can no longer afford to visit Florida this winter.

"A strong dollar is a double-edged sword that could hurt a lot of U.S. companies," said Lindsey Piegza, chief economist for Sterne Agee.

How is this likely to play out over time?

It could turn out just fine over the next year or two. In this good scenario, the European Central Bank would lower interest rates just enough to encourage European companies to borrow money and expand. With energy being so cheap now, this could indeed be the perfect time to take a chance on expanding a plant.

That would lead to more hiring, which would help consumer spending in Europe. Once growth picked up, the euro's value would rise. In the end, the United States would have a healthy trading partner again and a more reasonably priced currency, allowing for fair global competition.

But there could be a bad scenario: Europe's economy could keep shrinking, with the euro becoming unstable and the dollar getting way overpriced. The bottom line would be less business for U.S. manufacturing and tourism, and the U.S. economy would start to sink too.

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