Value of the U.S. Dollar Compared to Other Currencies:
Exchange Rate Trends:
The dollar weakened 20% against the euro between March 3 - December 1, 2009. The $12 trillion U.S. debt reduces confidence in the dollar's value.
During the credit crisis, (April 2008-March 2009) the dollar strengthened 22% as businesses hoarded dollars since credit wasn't available.
Before that (2002 - 2008), the dollar lost 40% of its value while the debt increased by 60%. In 2002, a euro was worth 87 cents vs $1.51 on December 1, 2009. (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 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 European Union, demand for the euro increases.
- Foreign investors are diversifying their portfolios with more non-dollar denominated assets.
- As the dollar loses value, investors are less likely to hold assets in dollars as they wait for the decline to stop.
Value of the Dollar as Measured by Treasury Bonds:
Between April 2008 and March 2009, the yield dropped from 3.57% to 2.93%, indicating a stronger dollar. Prior to that, the Treasury yield stayed in a range of 3.91% - 4.23%, indicating a stable dollar value. This made it a world currency. (Source: U.S. Treasury, Daily Treasury Yield Curve Rates)
Since January 2009, the value of the dollar is weakening as measured by both exchange rates and by Treasuries. The world is in a recession, investors want a safe investment, and the dollar is looking less safe thanks to the $12 trillion U.S. debt. The higher the debt, the less safe the dollar seems. To fund the debt, the Treasury is auctioning more notes than there is demand, causing yields to rise.
Value of the Dollar as Measured by Foreign Currency Reserves:
As of Q2 2009 (most recent report), there was $2.68 trillion in foreign government reserves held in dollars. This represents 63% of total measurable reserves, down from Q3 2008, when dollars comprised 67% of 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, the value of euros held in reserves increased from $393 billion to $1.17 trillion during this same time period. Although it is increasing rapidly, it is still less than half the amount held in dollars. (Source: IMF, COFER Table)
How the Value of the Dollar Affects the U.S. Economy:
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 $12 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 December 8, 2009)
