The pros and cons of the dollar being strong

updated 7:43 p.m. ET Feb. 9, 2009

NEW YORK - A robust dollar sounds like a good thing. But for U.S. companies that do a lot of business in foreign markets, it can turn seemingly strong overseas sales into much weaker ones.

As companies that make and sell goods abroad report their latest quarterly financial results, many are blaming lower profits on currency exchange rates. Both Burger King Corp., the nation's No. 2 hamburger chain, and cosmetics maker The Estee Lauder Cos. said last week their profits dropped as international sales translated into fewer dollars.

How serious a hit are U.S. companies taking from the strength of the dollar? And did they see this problem coming?

Here are some questions and answers about the how the dollar has affected company earnings.

Q: Why are so many companies saying the strong dollar hurt their earnings?

A: Most U.S. companies that sell goods overseas — whether it be food, makeup, equipment or clothing — translate their sales abroad from foreign currencies into dollars when they report their financial results. If the dollar is stronger than those currencies, the translation results in fewer dollars in revenue.

Here's an example: Let's say a dollar is worth the same as a euro. If an American company sells an item in Europe for a profit of 10 euros, the company can turn that profit into $10. Now let's assume that the dollar strengthens, so it only takes 80 cents to buy a euro; suddenly, that same 10-euro profit will only earn the company $8.

In this scenario, a U.S. company could maintain a constant level of earnings in a foreign country — or even increase its earnings in that country — but the number of U.S. dollars it takes in from there could go down.

A strengthening dollar also decreases the buying power of overseas consumers since their money is worth fewer dollars. That can affect companies' underlying sales and lead to declining profit.

Q: Did companies that sell products overseas see this coming? Don't they track currency movements?

A: Most do track exchange rates, but the sharp rise in the dollar caught even currency experts off guard. Before last fall, the dollar had been weakening for nearly six years due to wars abroad and low interest rates. (Wars are expensive and typically require the government to put more money into circulation, which can devalue currency. Lower interest rates lead to reduced demand for investments in U.S. government debt, and that translates into less demand for dollars — which means a weaker dollar.)

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Most economists had expected the dollar to weaken even further as the economy fell deeper into a recession — the typical path for the dollar in bad economic times.

But no one could have predicted the bankruptcy of Lehman Brothers amid the fallout from the subprime mortgage crisis. The collapse of the investment bank roiled stock markets around the world and led many foreign investors to flock to the safest assets they could find: investments in U.S. government debt. As more people invested in Treasury bills, notes and bonds — all of which are made out in dollars — the demand for the dollar went up, increasing its value against other currencies.

"Lo and behold, we've seen the dollar attract capital from around the globe," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group LLC. "That's really gone against the grain."

The economic crisis in the U.S. has made forecasting exchange rates even more difficult. Any bailout, rescue or stimulus plan that requires the government to pay for something will probably require putting more money into circulation. And that usually leads to a weaker dollar.

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