Dollar Is Losing Value Over the Long-term:
- The U.S. debt is more than $16 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.
- 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.
The Dollar Value Is Measured by Exchange Rates:
Dollar Value Compared to Euro:
- 2012 - The dollar lost value against the euro, as it appeared the eurozone crisis was being managed. By the end of 2012, the euro was worth $1.3186.
- 2011 - The dollar's value against the euro fell 10%, then regained ground. As of December 30, 2011, the euro was worth $1.2973.
- 2010 - The Greece 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 global financial 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, Exchange Rates)
The Dollar's Value Is Measured by Treasury Notes:
- 2012 - The dollar strengthened significantly, as the 10-year Treasury note yield fell in June to 1,443 -- a 200-year low. By the end of the year, the yield had risen to 1.78%. (Remember, low yields means a strong demand for Treasuries and dollars.)
- 2011 - The dollar weakened in early spring but rebounded by the end of the year. The 10-year Treasury note yield was 3.36% in January, rose to 3.75% in February, then plummeted to 1.89% by December 30.
- 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 $16 trillion U.S. debt. During the recession, 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 quantitative easing plan sopped up some of the excess by monetizing the debt. The dollar benefited from a temporary flight to safety, as investors worried about the outcome of the 2012 Presidential campaign and the fiscal cliff.
Value of the Dollar as Measured by Foreign Currency Reserves:
As of Q3 2012 (most recent report), there was a record $3.716 trillion in foreign government reserves held in dollars. This represents 61.8% 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, despite the eurozone crisis. Despite this growth, this 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 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.