Introduction to Finance

Personal Financial Planning

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6.5 Conducting Business Internationally
143
These economic developments, coupled with a favorable political climate, caused the value of 
the dollar to rise sharply.
However, the renewed strength of the dollar contributed to a worsening of the trade 
imbalance, because import prices were eff ectively reduced while exported U.S. goods became 
less cost competitive. Beginning in 1985, United States economic growth slowed relative 
to economic growth in other developed countries. Also, the belief that the U.S. government 
wanted the dollar to decline on a relative basis so as to reduce the trade defi cit contributed to 
a decline in the desirability of holding dollars. This resulted in a major shift toward holding 
more foreign assets and fewer U.S. assets. As a consequence, the dollar’s value declined by 
1987 to levels below those in place when fl exible exchange rates were reestablished in 1973. 
Between 1987 and 2000, the value of the dollar in international exchange fl uctuated within a 
fairly narrow range compared to the 1980–1987 period. 
CRISIS
The U.S. dollar appreciated relative to other currencies in 2000 and 2001. Stock prices 
peaked in 2000 and then began declining rapidly as the “Internet/tech” bubble burst. Declining stock 
prices were followed by a recession in 2001 and the terrorist attack on September 11, 2001. After 
fi rst raising interest rates, the Federal Reserve moved quickly to reduce interest rates and to provide 
liquidity in the fi nancial markets. The Fed then continued its high liquidity, low interest rate envi-
ronment throughout the remainder of the decade. This fi nancial markets environment was accom-
panied by large amounts of borrowing by business fi rms, fi nancial institutions, and individuals. 
Housing prices peaked in 2006, stock prices peaked in 2007, the fi nancial crisis developed 
in 2007–08, and the U.S. economy entered the Great Recession in 2008–09. Debt-heavy indi-
viduals began defaulting on their home mortgages, fi nancial institutions were fi nding it diffi
-
cult to remain solvent, and business fi rms were failing during this “perfect fi nancial storm.” 
These economic developments were accompanied by a rapid decline of the U.S. dollar against 
an index of major currencies beginning in 2002. Figure 6.2 shows this decline generally con-
tinuing until it reached a bottom in 2011. Since then, the U.S. dollar has been rising against an 
index of other major currencies.
In contrast, a stronger dollar leads to concern about the defi cit in the U.S. trade balance, 
but at the same time it off ers hope of lower infl ation. A stronger dollar results in more imports 
of foreign merchandise since it requires fewer dollars for purchases. Just as a U.S. tourist 
abroad fi nds it cheaper to travel when the dollar is strong, importers fi nd prices lower when 
their dollars increase in relative strength. When the dollar weakens, infl ation may follow, 
countered by a reduced balance of trade defi cit. We discuss balance of trade and balance of 
payments implications in the last section of this chapter.
Managing Currency Exchange Risk