U.S. Dollars (often abbreviated as USD or simply '$') are the official currency of the United States and its territories. But for an investor, the dollar is much more than just the money in your wallet. It's the world's primary reserve currency, meaning central banks and major financial institutions across the globe hold vast quantities of it. This global dominance makes the dollar a cornerstone of the international financial system. Commodities like oil and gold are priced in it, and a huge chunk of global trade is settled with it. Understanding the dollar's role is crucial because its value against other currencies, like the Euro or the British Pound, is constantly shifting. These fluctuations can dramatically impact your investment returns, especially when investing in companies outside your home country. For a value investor, the dollar isn't just a medium of exchange; it's a benchmark for value, a potential safe haven, and a source of risk that must be managed.
For those of us focused on the long-term value of businesses, it can be tempting to ignore the day-to-day chatter of currency markets. However, the dollar's status weaves its way into every corner of a global portfolio.
When global markets panic, where do investors run? Very often, they run to the U.S. dollar. This “flight to safety” happens because the U.S. financial markets are the deepest and most liquid in the world, and its political system is perceived as relatively stable. In times of crisis, investors prioritize the return of their money over the return on their money. They sell riskier foreign assets and pile into U.S. government bonds or simply hold dollars. Interestingly, this can happen even when a crisis originates in the U.S., as seen during the 2008 financial meltdown. The dollar strengthened because, in a world of trouble, it was still seen as the “cleanest shirt in the dirty laundry.” For a portfolio, holding some cash in U.S. dollars can act as a cushion during turbulent times.
The dollar serves as the world's default unit of account. When you read the financial statements of giants like Apple or Microsoft, their revenues, profits, and assets are all stated in USD. When you check the price of crude oil or copper, it's quoted in USD. This makes the dollar a global benchmark. For a European investor, this means you must perform an extra step when analyzing a U.S. company. To truly understand its value in your own terms, you need to consider the current exchange rate. A company that looks cheap in a strong-dollar environment might look expensive if the dollar weakens against your home currency.
This is one of the most overlooked risks for ordinary investors. Currency risk (or exchange rate risk) is the potential for your investment returns to be wiped out by unfavorable moves in the currency markets. Imagine you're a European investor and you buy a U.S. stock for $100 when the exchange rate is 1 EUR to 1 USD. A year later, the stock has risen a healthy 10% to $110. Great! But what if the dollar has weakened, and the exchange rate is now 1 EUR to 1.10 USD?
Your 10% stock gain was completely erased by the 10% move in the currency. Your profit in U.S. dollar terms vanished when you converted it back to your home currency. This risk works both ways, of course, but a value investor must always be aware of it when buying foreign assets.
The dollar's value isn't random; it's driven by powerful forces in the global economy.
The single most important driver of the dollar is the U.S. central bank, the Federal Reserve (the Fed). The Fed sets the key U.S. interest rate, known as the Fed funds rate. The rule of thumb is simple:
Beyond interest rates, the dollar's value reflects the relative health of the U.S. economy. Strong GDP growth, low unemployment, and booming corporate profits attract foreign investment, which supports a stronger dollar. Conversely, if the U.S. economy looks weak compared to, say, Europe or Asia, capital will flow out, and the dollar will weaken. This is a fundamental concept of macroeconomics playing out on a global stage. General market sentiment also plays a huge role; in a “risk-on” environment, investors might sell safe-haven dollars to buy riskier assets in emerging markets.
As value investors, our primary focus should always be on finding wonderful businesses at fair prices by analyzing their intrinsic value. However, we cannot operate in a vacuum. The U.S. dollar is a fundamental part of the investment landscape that provides crucial context. Before you invest internationally, ask yourself: Is the dollar currently strong or weak against my home currency? A strong dollar might make foreign assets look cheap, while a weak dollar can inflate their cost. Understanding the dollar cycle helps you avoid overpaying for assets and manage the hidden currency risk in your portfolio. The dollar isn't just money; it's a vital piece of the global investment puzzle.