Factors Affecting the Value of the US Dollar
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When we talk about the US dollar value, we are typically talking
about two things:
1. The purchasing power of the dollar and how that purchasing
power changes in a specific economy (the United States) over
time.
2. The value of the dollar relative to other global currencies.
The change in the relative purchasing power of a dollar in
the United States is measured and reported each year by changes
in the Consumer Price Index (CPI). Another way of referring
to these changes is inflation (or in some cases deflation).
In our increasingly global economy, the value of the US dollar
is measured continuously by comparing changes in its value
to other currencies. For example, once can measure and track
its relative value vs. the Japanese Yen, or the European Euro
over a period of months or years. Its value compared to other
currencies is reflected in its exchange rate. The exchange
rate is simply the rate at which you can trade or convert
one currency (the US dollar, for example) for another currency
(Japanese Yen, for example). Historically, the US dollar has
remained relatively stable and has been considered a strong
currency because it maintained a high value relative to other
currencies. Recent years, however, have seen some significant
declines in the value of the dollar vs. other global currencies.
This has been caused by a number of factors, including the
rising US national debt, an increasing annual US deficit,
and the trade imbalances that have been increasing in favor
of other exporting countries over time.
As the value of the dollar declines relative to other global
currencies, U.S. produced goods become cheaper and more competitive
when compared to goods and services produced by foreign countries.
This has a positive effect on US firms who are exporting goods
to other countries. However, it also increases the prices
of goods being shipped in to the US (in dollar terms). A declining
currency value translates quickly into a reduction in purchasing
power. In other words, US consumers are able to buy fewer
and fewer of the now relatively more expensive foreign produced
goods with our weakening legal tender. The escalating prices
of products imported from foreign countries can also result
in higher inflation over time.
These persistent trends have resulted in a substantially
weaker dollar over the past several decades relative to other
major global currencies. In fact, during period between 2000
and 2007, its value declined by about 40% vs. the European
Euro.
It is important to note that in the last few years (late
2008 and early 2009), this weakening trend has reversed itself
to a point. As the global economy has begun to sink deeper
and deeper into an economic recession, investors are increasingly
drawn to the US dollar as a safe haven for their investment
portfolios. The United States is still perceived to have long-term
financial staying power even when compared to other substantial
and historically strong and stable economies and currencies
such as those of the European Union and Japan.
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