Beware of the Rising Dollar

For years, the dollar's steep decline had economists predicting dire consequences for the American economy. But now, with the economy is in recession and many fearing far worse down the road, the dollar has ironically made a big rebound against nearly every currency in the world, with the notable exception of the Japanese yen.

Unfortunately, now that the dollar has strengthened substantially in recent months, few people seem to be celebrating. And while the rising dollar certainly comes with some downsides both for U.S. businesses and for your investments, it does make some opportunities that the bear market has brought even more attractive.

Be careful what you ask for
Traditionally, a strong dollar has brought many benefits for American consumers. Most people notice exchange rates the most when they travel abroad, as they see how much their dollars will buy them and compare current rates with the experiences they've had on prior trips.

But even when you stay close to home, foreign exchange rates have a dramatic impact on your economic life. Anytime you buy something made in a foreign country, exchange rates play a pivotal role in determining how much you pay for it. And even if you stick with products that are made domestically, even U.S. manufacturers have to make pricing decisions with the global marketplace in mind.

So with the dollar up, why aren't people getting more optimistic about the economy?

No money for cheaper goods
The problem this time around is that the typical benefits of a rising dollar -- lower prices for imported goods and services -- come with a catch. Domestic manufacturers, already under pressure from the ailing economy, will be forced to lower their prices in order to stay competitive with foreign companies and their cheaper imports.

That isn't so bad when the economy is expanding. But lately, corporate revenues and profits have already gotten pinched. Just take a look at recent results from a few representative companies:

Source: Capital IQ, a division of Standard and Poor's. Revenue and net profit figures are for most recent quarter compared with year-ago quarter. Returns as of Dec. 5.

If the rising dollar and increased competition at home squeeze profits even further, it spells potential disaster for those companies that rely on their American operations to generate profits.

The other side of the coin
On the other hand, multinational corporations like General Electric (NYSE:GE) and Merck (NYSE:MRK) benefited when the dollar was low, as their foreign profits were worth more in dollar terms. Now that the dollar is rising, that trend has reversed -- meaning that those companies can't look abroad for extra profits to offset their troubles at home.

With businesses suffering, investors haven't seen any good news for a long time. But there is a silver lining -- if you're willing to look beyond the most obvious investments.

Time to go shopping
International investors have taken double damage with the rising dollar. Not only have most foreign stocks fallen, but dropping foreign exchange rates have also made their value in dollars fall even faster. Those who jumped on the international bandwagon late in the game, after several stellar years during the bull run, have seen most or all of their returns go up in smoke.

But if you've been waiting for the right chance to invest internationally, the rising dollar has rewarded your patience. A stronger dollar goes further in buying shares of foreign companies -- and as attractive as the opportunities are in the U.S., you'll find even more interesting stocks beyond our borders.

So even if the dollar's rebound hasn't been the panacea many hoped for, it's not entirely without benefits for astute investors. If you see the current troubles as the catalyst for an awakening in foreign markets, now's a great time to find the companies you think will make the largest contributions, and invest in them today.

More Foolishness about the humble buck:

• An ETF made to profit from a rising dollar.
• Other ways to win with dollar strength.
• What to do if the dollar starts to fall again.