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Value of the U.S. Dollar

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Dollar Is Losing Value Over the Long-term:

The dollar's value can be measured by exchange rates, Treasury notes and the amount of dollars held by foreign countries. These three measurements usually are in sync with each other. No matter how you measure it, the dollar is losing value over the long-term. Here's why:
  1. The U.S. debt is over $14 trillion. Foreign holders of this debt are concerned that the U.S. will let the dollar value decline so the relative value of its debt is less.
  2. The large debt could force the U.S. to raise taxes to pay it off, which would slow economic growth.
  3. As more countries join or trade with the European Union, demand for the euro increases.
  4. Foreign investors are diversifying their portfolios with more non-dollar denominated assets.
  5. As the dollar loses value, investors are less likely to hold assets in dollars as they wait for the decline to stop.

The Dollar Value Is Measured by Exchange Rates:

The U.S. dollar is most easily measured by its exchange rate, which compares its value to other currencies. Currency exchange rates allow you to determine how much of one currency you can exchange for another. Exchange rates change every day because currencies are traded on the foreign exchange market, known as forex. A currency's forex value depends on a lot of factors, including Central Bank interest rates, the country's debt levels, and the strength of its economy. Most countries allow their currencies to be determined by the forex market. This is known as a flexible exchange rate.

Dollar Value Compared to Euro:

  • 2011 - The dollar's value against the euro fell 10%, then regained ground. As of October 7, 2011, the euro was worth $1.35.
  • 2010 - The EU debt crisis strengthened the dollar. By year end, the euro was only worth $1.32.
  • 2009 - The dollar fell 20% thanks to debt fears. By December, the euro was worth $1.43.
  • 2008 - The dollar strengthened 22% as businesses hoarded dollars during the credit crisis. By year end, the euro was worth $1.39.
  • 2002-2007 - The dollar fell 40% as the U.S. debt grew 60%. In 2002, a euro was worth $.87 vs $1.44 by December 2007. (Source: Federal Reserve Bank, Exchange Rates)

The Dollar's Value Is Measured by Treasury Notes:

The dollar's value is usually in sync with demand for U.S. Treasury notes. The Treasury Department sells notes for a fixed interest rate and face value. Investors bid at a Treasury auction for more or less than the face value, and can resell them on a secondary market. High demand means investors pay more than face value, and accept a lower yield. Low demand means investors pay less than face value and receive a higher yield. That's why a high yield means low dollar demand - until the yield goes high enough to trigger renewed dollar demand.

  • 2011 - Here again, as the dollar weakened in April but rebounded by October. The 10-year Treasury note yield was 3.36% in January, rose to 3.75% in February, then fell to 2.24% in October. (Remember, high yields compensate for low dollar value.)
  • 2010 - The dollar strengthened, as the yield fell from 3.85% to 2.41% (January 1-October 10). It then weakened due to inflation fears from the Fed's QE2 strategy.
  • 2009 - The dollar fell as the yield rose from 2.15% to 3.28%.
  • 2008 - The yield dropped from 3.57% to 2.93% (April 2008-March 2009), as the dollar rose.
  • Prior to April 2008, the yield stayed in a range of 3.91%-4.23%, indicating a stable dollar demand as a world currency. (Source: U.S. Treasury, Daily Treasury Yield Curve Rates)

The value of the dollar, whether measured by exchange rates or Treasury yields, is undermined by the $14 trillion U.S. debt. During the 2008 financial crisis, investors wanted a safe investment, which strengthened the dollar. When global confidence picked up, the dollar resumed its downward trend and Treasury yields rose as long as the Federal government auctioned more notes to fund the debt. The Fed's QE2 plan sopped up some of it, by monetizing the debt. However, the Greek debt crisis and a slowdown in economic growth in 2011 strengthened the dollar as investors resumed their flight to safety.

Value of the Dollar as Measured by Foreign Currency Reserves:

The dollar is held by foreign governments who have an excess of dollars, which they hold in foreign currency reserves. The excess happens when countries, such as Japan and China, export more than they import. As the dollar declines, the value of their reserves also decline. As a result, they are less willing to hold dollars in reserve. They diversify into other currencies, such as the euro or even the Chinese yuan. This reduces demand for the dollar, putting further downward pressure on its value. Some experts fear that Japan's 2011 earthquakewill force it to sell its dollar reserves, which it holds as Treasuries, to pay for reconstruction from the disaster.

As of Q2 2011 (most recent report), there was a record $3.28 trillion in foreign government reserves held in dollars. This represents 60% 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 $1.45 trillion during this same time period. Although it increased 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:

When the dollar declines, it makes U.S. produced goods cheaper and more competitive when compared to foreign produced goods. This helps increase U.S. exports, boosting economic growth. However, it also leads to higher oil prices in the summer, since oil is priced in dollars. Whenever the dollar declines, oil producing countries raise the price of oil to maintain profit margins in their local currency.

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 raise the price of oil, which they do by threatening to limit supply. You notice this when you pay more for gas each week. Find out more ways it affects you in The Value of Money.

The growing U.S. debt weighs in the back of the minds of foreign investors. That's 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.

The Value of the Dollar Over Time

The dollar's value can also be compared to what it bought in the U.S. in the past. Make some comparisons with the past in Today's Dollar Value.(Article updated October 12, 2011)

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