How does the more expensive dollar affect Dutch consumers?

Current issues related to economics, (responsible) investment, pensions and income: every week an APG expert provides a clear answer to the question of the week. This time: Thijs Knaap, chief economist at APG, talks about the consequences of the strong dollar for Dutch consumers.

At the start of 2021, one euro would fetch 1.22 dollars. At the beginning of this year, it was still 1.14 dollars and now the exchange rate of the euro has fallen to around 1.07. This means the euro is still worth a little more than the U.S. currency, but the difference is pretty small. Just after the introduction of the euro, at the beginning of this century, was the last time that the dollar was stronger than the European currency. At that time, you’d get a paltry 83 cents for your euro. Around the credit crisis of 2008, however, the euro was very strong again and was worth 1.60 dollars. So, the exchange rate fluctuates considerably. What factors play a role in this? And what does the Dutch consumer notice about the more expensive dollar?

More expensive vacations

With an exchange rate, three things come into play, Knaap explains. “Dutch consumers immediately experience the first one. That is because American products that you have to pay for in dollars, for example on the internet, become more expensive. Vacations to America also become pricier.” In addition, there is an indirect consequence. “Very generally, you can say that there are two large economic blocs that compete in the world market: America and Europe. Our power as Europe to buy products such as gasoline on the world market at a competitive price, for example, depends very much on what the euro is worth against the dollar. Now that the euro is weaker, we have to bid against the stronger dollar on the world market. That leads to products currently becoming more expensive for us than for Americans.”

The second force that plays a role in the exchange rate is the financial markets. “There is always a need to put excess money away somewhere in the world, for example in a bank or by buying a government bond. Then it matters what the interest rate is, and it is now quite high in America and quite low in Europe. So, it is more attractive to put money away in America, which increases the demand for dollars and makes that currency more expensive. The current high interest rate in the US is therefore the biggest reason for the strong dollar. Because although the global flows of goods are big, the financial flows are even bigger. These therefore have the greatest impact on the dollar exchange rate. If the European Central Bank were to raise interest rates now, the euro would become somewhat stronger, but that does not have a one-to-one effect. Financial markets also take into account expectations about the U.S. and European economies. The European economy is somewhat weaker, for example due to the war in Ukraine. The rise in US interest rates will therefore be stronger than in the eurozone.”  

Safe haven

The fact that the dollar is still seen as a safe haven is the third factor influencing the exchange rate. “Anytime there is a calamity somewhere in the world, like right now the war in Ukraine, investors get scared and take their money to the U.S. and buy dollars. They do so because they have learned through trial and error that at the time of misfortune, the dollar rises in value. There is some debate as to whether the US really is that safe for investors anymore. Think of the period under President Trump, for example. But for now, Washington has nothing to worry about. Just look at the beginning of this year: Russia invades a country and boom, all the money goes to the US.”

There is also a reason to be happy with a cheap currency. After all, European products are now cheaper on the world market and will therefore be sold more, which in turn can lead to more employment, for example. In that sense, Europeans can benefit indirectly from a cheap European currency. This also applies to the Netherlands, although additional employment can currently also lead to a further tightening of the labor market. “Despite the fact that a large part of our exports remain within the euro zone, trade with non-euro countries still plays a major role in the Dutch economy. A cheap euro is therefore not only good for exports of German and French cars or Italian fashion, but also for Dutch exporters.”

Long term

So, possibly extra jobs for the Netherlands, but also more expensive American products and vacations. Those prices will only go down again when the exchange rate of the euro rises. What is needed for that? “In the short term, a higher interest rate,” Knaap says. “In the long run, it will work itself out: the cheaper euro will lead to so much trade that demand for euros will increase and demand for dollars will decrease. An end to the war in Ukraine will also make for a stronger euro.” For now, the U.S. currency will remain strong, Knaap expects. “In the US, they’re really raising interest rates, which will further shore up the dollar. I would venture to say that the dollar will be a lot weaker in five years, but next year it may well be stronger than it is now.” So, for the time being, American products and vacations will remain relatively expensive for Dutch consumers.