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Value of the U.S. Dollar

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Value of the U.S. Dollar Compared to Other Currencies:

The U.S. dollar is most easily measured by its exchange rate, which compares its value to other currencies. Exchange rates change every day because currencies are traded on an open market.

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:

  1. 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.
  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.

Value of the Dollar as Measured by Treasury Bonds:

The value of the dollar is also measured by the demand for U.S. Treasury bills, notes and bonds. Treasury bills, notes and bonds are sold at auction by the U.S. Treasury Department and can be bought for more or less than the face value, depending on demand. They can also be resold on the open market, and the price can fluctuate further. The greater the demand, the lower the yield that the Government has to pay investors. Conversely, when demand falls, then the Government must pay a higher yield to attract investors back.
Since January 2009, the value of the dollar as measured by Treasuries agreed with its value as measured by exchange rates - it weakened. By December 1 2009, the 10-year Treasury note yield rose to 3.28% - a 52.6% increase from the 2.15% yield on January 15. An increase in the Treasury yield is a decrease in dollar value.

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:

The dollar is held by foreign governments who have an excess of cash, held in foreign currency reserves. This excess happens when countries, such as Japan and China, export more than they import. Since these countries are concerned about the declining dollar, there is a decline in the percentage of reserves held in dollars.

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:

When the dollar declines, it makes U.S. produced goods cheaper and more competitive when compared to foreign produced goods. This could help 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 may 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 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)

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