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The U. S. Dollar Index

By , About.com Guide

Dollar Index

The dollar index measures the dollar's value against a basket of weighted currencies.

(Credit: Getty Images)
The U.S. dollar index measures the dollar's value against the currencies of other important countries. There are two commonly used dollar indices: the USDX (U.S. Dollar Index) and the Federal Reserve's H-10 Trade-Weighted Index.

What Does the U. S. Dollar Index Measure?:

The USDX measures the strength of the dollar against six of the most widely-traded currencies. They, and their countries, are: euro (the 13 countries in the European Union that have adopted the euro), yen (Japan), pound sterling (Great Britain), dollar (Canada), krona (Sweden) and franc (Switzerland).

The U.S. trades more with some countries than with others. This means U.S. companies have more risk exposure to those countries' currencies. Therefore, the dollar index weights each currency to reflect that risk as follows:

  • Euro (EUR) 57.6%
  • Yen (JPY) 13.6%
  • Pound (GBP) 11.9%
  • Dollar (CAD) 9.1%
  • Krona (SEK) 4.2%
  • Franc (CHF) 3.6%.
As you can see, the euro is weighted more heavily than all the other currencies combined. This means that when the euro changes it pretty much dictates what happens to the USDX unless all the other currencies move in the opposite direction to compensate for it. For example, if the euro loses value, the dollar's value as measured by the USDX rises. The only exception would be if all the other currencies rose enough to counterbalance the euro's fall.

The USDX is an index since it compares the dollar to so many different currencies. This is different from all other exchange rates, which compares only two currencies at a time. The USDX index started at 100 on March 1973 when it was created. Therefore, the USDX current value tells you the percent change of the dollar since then. For example, on August 3, 2012 the USDX closed at 82.38. This meant the dollar had lost 17.62% of its value since 1973, when the USDX was 100.

Why was 1973 chosen as the base year? The USDX was created by the Federal Reserve in March 1973 to measure the value of the dollar. The U.S. abandoned the gold standard in its fight against stagflation. This was the end of the Bretton Woods Agreement, and it allowed the dollar to float freely.

How the USDX Is Used:

The USDX is primarily used as a gauge to determine the relative buying power of the dollar. Even though the euro is so heavily weighted, the USDX is a more accurate reflection of the dollar's strength than just a dollar to euro comparison alone.

The USDX is also traded. In 1985, traders started writing futures contracts on the USDX. In 1986, they were able to take out options on these futures contracts.

Both of these trades can be used in one of two ways. Corporations that have exposure to the six currencies in the USDX can hedge against volatility, or the probability that the currencies will change significantly. That reduces risk for those companies. Forex traders can also trade the USDX based on what they think the dollar will do. If they think the dollar will strengthen, they can buy a futures contract or an option that will pay out if that happens. (Source: InterContinental Exchange, ICE Dollar Index FAQs, 2012)

The Federal Reserve H-10 Dollar Index:

In 1998, the eurozone was created, and the Federal Reserve realized the bias of the USDX. It created a trade-weighted index that more accurately reflected the dollar's strength against the currencies of major U.S. trading partners. The currencies selected represented the 26 countries that the U.S. trade with the most. Unlike the USDX, this index is updated annually to reflect current trading exposures.

These countries, and their weights as of 2012, are:

  1. Eurozone - 16.36%
  2. Canada - 13.23%
  3. Japan - 7.796%
  4. Mexico - 11.452%
  5. China - 19.756%
  6. United Kingdom - 3.541%
  7. Taiwan - 2.601%
  8. Korea - 3.858%
  9. Singapore - 2.037%
  10. Hong Kong - 1.307%
  11. Malaysia - 1.836%
  12. Brazil - 2.068%
  13. Switzerland - 1.684%
  14. Thailand - 1.450%
  15. Philippines - .6%
  16. Australia - 1.313%
  17. Indonesia - 1.111%
  18. India - 1.775%
  19. Israel - 1.086%
  20. Saudi Arabia - .806%
  21. Russia - 1.116%
  22. Sweden - .84%
  23. Argentina - .569%
  24. Venezuela - .4%
  25. Chile - .784%
  26. Colombia - .619%.
For more updated or historical weightings, see Federal Reserve H-10 Dollar Index Weightings. This trade-weighted index provides a better indication of the dollar's true value than the USDX. For this reason, it's also a better reflection of currency risk for U.S.-based corporations and investors. Article updated August 7, 2012

U.S. Dollar FAQ:

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