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The Economy and the U.S. Dollar

By manybanking.com Staff
As the world’s reserve currency, the value of the U.S. dollar is crucially important. Fluctuations in U.S. dollar’s value have wide-ranging implications.

The value of the U.S. dollar is most often measured by its exchange rate. This can be done in two ways -- using the U.S. Dollar Index (USDX), which uses weight comparisons to a basket of foreign currencies or making a direct comparison of the U.S. dollar to another foreign currency like the Euro. (EUR)

The value of the U.S. dollar has been declining against the Euro since 2002. In March of 2002, a Euro was worth about $0.87.  By 2008, the U.S. dollar had lost about 40% of its value, and in April 2007 the Euro was worth $1.60. That trend shifted, however, in the middle of 2008 and the U.S. dollar started to regain some of its value. As recently as March 2009, the euro was worth $1.25. Since then, the dollar has retreated in value some, but still remains up in comparison to early 2008.

The rally of the U.S. dollar value seems to have coincided with the global recession, which seems contradictory on the surface. By most measures, the American recession should hurt the exchange rate of the U.S. dollar. When compared with the rest of the world, however, the U.S. dollar has unique appeal. The revival of the U.S. dollar was caused more by a lack of confidence in the European economy than confidence in the American economy. Despite adverse U.S. market conditions, the American government, and it’s debt, is still looked on favorably by global investors.

When the Federal Reserve lowered interest rates to almost nothing at the end of 2008, the value of the U.S. dollar somewhat declined. The transfer of toxic assets from private banks to the government’s balance sheet was also a likely contributor to the U.S. dollar’s decline. But the U.S. dollar has since become stronger, as worries about European and Asian markets bring it up.

Most people don’t track the changing value of the U.S. dollar on a regular basis, but the U.S. dollar exchange rate has tangible effects on the economy and on the spending power of regular people. The obvious consequence of a more valuable U.S. dollar is making American travel abroad more affordable, but that is only one effect.

The U.S. dollar also affects oil prices.  When the dollar is high, oil-producing countries can afford to keep the price of oil relative low and maintain profit margins. When the value of the U.S. dollar declines, however, these countries often threaten to limit oil supply so that prices go up. This allows oil producers to maintain the same profit margins in their currency despite the lower value of the U.S. dollar.  For average consumers, this is felt in the price of gas, food and other commodities.

Imports and exports are also affected by changes in the U.S. dollar value. When the U.S. dollar was weaker, U.S. exports sales increased despite slowing domestic sales. As the U.S. dollar got stronger, exports declined, compounding alongside a decline in domestic sales as well.

On the other hand, when the dollar gets stronger, imports become more affordable for Americans. America imports a lot of things besides oil, and a strong dollar increases American’s buying power for imported goods. The negative effect on business, however, and the rising unemployment that results may offset that benefit.

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