Trends Over Time, Causes of Dollar Changes, and Impacts to the Economy

The value of the U.S. dollar is measured in three ways: exchange rates. Treasury notes and foreign exchange reserves (the amount of dollars held by foreign countries). The most common is exchange rates, but you should be familiar with all three to understand where the dollar might be headed next.

Recent Trends

All three measurements show an increase in the dollar’s value since 2011. Here’s why:

1. The dollar is a safe haven during any global crisis. That means investors purchase U.S. Treasuries to avoid risk as the world recovers from the 2008 financial crisis and recession .
2. The European Union still struggles to resolve the Greece debt crisis. This weakens demand for the euro. the world’s second choice for a global currency .
3. China’s attempts to reform its economy slowed growth in 2014, pushing investors back into the dollar.
4. Despite reforms, both China and Japan continue to purchase dollars to push the value of their own currencies down. This helps them boost exports by making them cheaper.

The recent strengthening reversed a downward decline that began in 2002. However, the following three pressures still exist, and should eventually push the dollar’s value down again in the long term.

1. The U.S. debt is more than $18 trillion. Foreign holders of this debt are always uneasy that the Federal Reserve will allow the dollar’s value to decline so U.S. debt repayments will be worth less in their own currency. The Fed’s quantitative easing program monetized the debt. artificially strengthening the dollar to keep interest rates low. Now that the program has ended, investors are concerned the dollar could weaken.
2. The large debt puts pressure on the President and Congress to either raise taxes or slow spending (most recently through sequestration ). This dampens economic growth, sending investors to chase higher returns in other countries.
3. Foreign investors prefer to diversify their portfolios with non-dollar denominated assets.

The Dollar’s Value As Measured by Exchange Rates:

The dollar is most commonly 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. 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. When these are strong, so is the value of the currency. For more, see How Does the Government Regulate Exchange rates ?

Most countries allow their currencies to be determined by the forex market. This is known as a flexible exchange rate. Find out the dollar’s value compared to the rupee, yen, Canadian dollar, and the pound in U.S. Dollar Rate .

Dollar Value Compared to Euro

• 2014 — The euro to dollar exchange rate fell to $1.21, thanks to investors fleeing the euro. For more, see Euro to Dollar Conversion .
• 2013 — The dollar lost value against the euro, as it initially appeared the EU was finally solving the eurozone crisis. By December, the euro was worth $1.3779.
• 2012 — By the end of 2012, the euro was worth $1.3186 as the dollar weakened.
• 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 As Measured by Treasury Notes

The dollar’s value is usually in sync with demand for 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.

• 2014 — The dollar strengthened through the year, as the yield on the benchmark 10-year Treasury note fell from 3.0% in January to 2.17% by year-end. (Remember, high yields means a weak demand for Treasuries and dollars.)
• 2013 — The dollar weakened slightly, as the yield on the 10-year Treasury rose from 1.86% in January to 3.04% by December 31.
• 2012 — The dollar strengthened significantly, as the yield fell in June to 1.443% — a 200-year low. The dollar weakened towards the end of the year, as the yield rose to 1.78%.
• 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 )

Value of the Dollar as Measured by Foreign Currency Reserves

The dollar is held by foreign governments in their currency reserves. They wind up stockpiling dollars because they export more than they import. They receive dollars in payment. Many of these countries find it’s in their best interest to hold onto dollars because it keeps their currency values lower. Some of the largest holders of U.S. dollars are Japan and China .

As the dollar declines. the value of their reserves also declines. 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.

As of Q3 2014 (most recent report), there was a record $3.855 trillion in foreign government reserves held in dollars. However, governments are diversifying, as this represents only 62% of the total measurable reserves, down from 67% in Q3 2008. 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 $1.398 trillion during this same time period, despite the eurozone crisis. Nevertheless, holdings in euros are 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 strengthens, it makes American-made goods more expensive and less competitive when compared to foreign-produced goods. This helps decrease U.S. exports. slowing economic growth. It also leads to lower oil prices. since oil is priced in dollars. Whenever the dollar strengthens, oil-producing countries can relax the price of oil, because their profit margins in their local currency aren’t affected.

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 strengthens 20% against the euro, the value of the riyal, which is fixed to the dollar, has also risen 20% against the euro. To purchase French pastries, the Saudis can now pay less than they did before the dollar got stronger. That’s why the Saudis didn’t need to limit supply as oil prices fell to $50 a barrel in 2014. Find out more ways it affects you in The Value of Money .

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 .

The growing U.S. debt weighs in the back of the minds of foreign investors. That’s why, long-term, they may continue to gradually move out of dollar-denominated investments. It will happen 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. Article updated January 12, 2015.