From March to September 2009, the dollar's value fell 14.9% against the euro. This is a result of the nearly $12 trillion U.S. debt, which reduces confidence in the dollar's value.
Prior to that, businesses hoarded dollars since credit wasn't available, creating an 11-month dollar strengthening cycle. The dollar's value increased 22% from April 2008 to March 2009,
For six years prior to that, the dollar weakened. Between 2002 - 2008, the dollar lost 40% of its value. In 2002, a euro was only worth 87 cents.(Source: Federal Reserve Foreign Exchange Rates; Federal Reserve Bank of New York, Historical Exchange Rates)
The dollar is declining for the following reasons:
- The U.S. debt is rising to over $12 trillion. Foreign investors are concerned that the U.S. will let the dollar decline so the relative value of its debt is less.
- The large debt could force the U.S. to raise taxes to pay it off, which would slow economic growth.
- As more countries join or trade with the EU, demand for the euro will increase.
- Foreign investors may want to diversify their portfolios with more non-dollar denominated assets.
- As the dollar resumes its decline, investors will be less likely to hold assets in dollars as they wait for the decline to stop.
In the seven years prior to that, the Treasury yield had been declining. The January yield of 2.15% was 57% lower than the March 2002 yield of 5.02%. This meant that the demand for dollar-denominated Treasury notes was strong. (Source: U.S. Treasury, Daily Treasury Yield Curve Rates)
Since January, the value of the dollar is weakening as measured by both exchange rates and by Treasuries. The world is in a recession, and investors want a safe haven. The higher the U.S. debt level, the less safe the dollar seems. Basically, the Treasury is auctioning more notes than there is demand, forcing yields to rise.
In fact, as of Q4 2008 (most recent report), there was at least $2.7 trillion of foreign government reserves held in dollars. This represents 64% of total measurable reserves, down slightly from Q3 2008, when dollars comprised 67% of measurable reserves. Since the percentage of dollars is slowly declining, this means that foreign governments are slowly moving their currency reserves out of dollars. In fact, Euros held in reserves increased from 393 billion to 1.1 trillion during this same time period. (Source: IMF, COFER Table)
For example, the dollar is worth 3.75 Saudi riyals. Let's say a barrel of oil is worth $100, which makes it worth 375 Saudi riyals. If the dollar declines 20% against the euro, two things happen. First, the value of a barrel of oil has declined 20% to the Saudis. Second, the value of the riyal, which is fixed to the dollar, has also declined 20% against the euro. To purchase French pastries, the Saudis must now pay more than they did before the dollar declined. To avoid this, the Saudis must raise the price of oil, which they do by threatening to limit supply.
The $11 trillion U.S. debt is weighing in the back of the minds of foreign investors. That is why they may continue to gradually move out of dollar denominated investments - slowly, so they don't diminish the value of their existing holdings.The best protection for an individual investor is a well-diversified portfolio that includes foreign mutual funds. (Last updated May 19, 2009)
