Three different ways to measure the value of the US dollar

15.04.2019 * reading time: 10min


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15.04.2019 reading time: 10min

Three different ways to measure the value of the US dollar, … which is where the US dollar is headed.

The value of the US dollar is measured in three ways: exchange rates, government bonds and currency reserves. The most common method is the exchange rate. You should be familiar with all three to understand where the dollar is headed.

Exchange rate

The exchange rate of the dollar compares its value to the currencies of other countries. It lets you specify how much of a particular currency you can exchange for a dollar. The most popular measurement of the exchange rate is the US dollar index.
These rates change every day because currencies are traded on the foreign exchange market. The currency exchange rate on the forex market depends on many factors. These include central bank interest rates, the level of indebtedness of the country and the strength of its economy. When they are strong, the same is true for the value of the currency. The Federal Reserve has many monetary tools that can affect the strength of the dollar. These tools are the way the government can regulate exchange rates, even indirectly.

 Below you can follow the dollar value measured by the euro since 2002:

The following chronology explains in a simplified way why and how the value of the dollar changed.

20022007: The dollar fell by 40 percent, the US debt rose by 60 percent. In 2002, the Euro was worth $ 0.87 compared to $ 1.44 in December 2007.

2008: The dollar strengthened by 22 percent, companies accumulated dollars during the global financial crisis. By the end of the year, the euro was worth US $ 1.39.

2009: The dollar fell by 20 percent due to fears over debt. Until December, the euro was worth 1.43 USD.

2010: The Greek debt crisis strengthened the dollar. By the end of the year, the euro was worth only 1.32 USD.

2011: The value of the dollar against the euro fell by 10 percent. As at December 30, 2011, the Euro was worth US $ 1.30.

2012: Until the end of 2012, the Euro was worth 1.32 USD.

2013: The dollar depreciated against the euro, the European Union finally solved the eurozone crisis. Until December it was 1.38 USD.

2014: The euro / dollar exchange rate fell to $ 1.21 thanks to investors fleeing the Euro.

2015: Euro-dollar exchange rate fell to a low level of 1.05 USD in March and then increased to 1.13 USD in May. It fell to 1.05 USD after attacks in Paris in November, before the end of the year at 1.08 USD.

2016: The Euro rose to USD 1.13 on February 11, when Dow Dow lowered its value in the stock market correction. On June 25, it fell to USD 1.11. It happened the day after Great Britain voted to leave the European Union. Traders thought that the uncertainty associated with voting would weaken the European economy. Later, the markets calmed down when they realized that Brexit would take years. This allowed the euro to rise to USD 1.13 in August. Shortly thereafter, the euro fell to its lowest level in 2016 at USD 1.04 on December 20, 2016.

2017: By May, the euro rose to 1.09 USD. Investors bet on the Euro, perhaps partly in the aftermath of the allegations of links between the administration of President Trump and Russia. By the end of the year, the euro rose to USD 1.20.

2018: The euro continued its growth. February 15 was 1.25 USD. In April, the euro began to weaken after President Trump initiated a trade war. The euro fell on June 28 to $ 1.16, a few days after the Federal Reserve raised its federal funds rate to 2%. Higher interest rates strengthen the currency as investors receive a higher return on investment. By the end of the year, the euro was 1.15 USD.

Treasury bonds

The value of the dollar is synchronized with the demand for Treasury bonds. The US Treasury Department sells bonds with a fixed interest rate and face value. Investors bid more or less than the face value at the auction and may resell them on the secondary market. High demand means that investors pay more than their face value and accept lower profitability. Low demand means that investors pay less than their nominal value and receive higher profitability. High profitability means low demand for the dollar, until profitability is increased enough to trigger a renewed demand for the dollar.

Before April 2008, the yield on the 10-year Treasury bond remained at 3.91%. up to 4.23 percent. This indicated stable demand for the dollar as the world currency.

2008: the yield on 10-year government bonds fell from 3.57%. up to 2.93% From April 2008 to March 2009, as the dollar grew. Falling profitability means growing demand for bonds and dollars.

2009: The dollar has fallen, profitability increased from 2.15%. Up to 3.28%.

2010: From 1 January to 10 October, the dollar strengthened, as profitability fell from 3.85%. up to 2.41% Then it weakened due to fears of inflation resulting from the Fed’s quantitative easing strategy2.

2011: The dollar weakened in early spring, but rebounded towards the end of the year. The yield on 10-year treasury bonds was 3.36 percent in January. In February it rose to 3.75 percent, and by December 30, it fell to 1.89 percent.

2012: The dollar has significantly strengthened, profitability fell to 1.443 percent in June, the lowest level in 200 years. The dollar weakened at the end of the year, as profitability increased to 1.78%.

2013: The dollar weakened slightly, the yield of 10Y bonds increased from 1.86 percent in January to 3.04 percent by December 31st.

2014: The dollar strengthened throughout the year, 10-year bond yield fell from 3 percent in January to 2.17 percent by the end of the year.

2015: The dollar strengthened in January, the yield of 10-year-olds fell from 2.12%. in January to 1.68 per cent In February, the dollar weakened when profitability increased to 2.28%. in May. The year ended at 2.24 percent.

2016: The dollar strengthened, profitability fell to 1.37 percent. on July 8, 2016. The dollar weakened, as profitability increased to 2.45%. at the end of the year.

2017: The dollar weakened, as profitability reached the peak of 2.62%. March 13. The dollar strengthened when profitability fell to 2.05 percent. September 7. Profitability increased to 2.49 on December 20, ending the year at 2.40.

2018: The dollar is still weakening. By February 15, the yield on the 10-year note was 2.9 percent. Investors were afraid of inflation return. Profitability remained in this range, rising to 3.09 percent on May 16, then falling to 2.69 percent by December.

Foreign reserves

The dollar is maintained by foreign governments in their foreign exchange reserves. Stocks of dollars are created because they export more than they import. They receive payment in dollars. Many of these countries believe that it is in their best interest to hold dollars because it keeps their currency values ​​at a lower level. One of the largest holders of American dollars is China, Japan, Brazil and the United Kingdom.
With the fall of the dollar, the value of its reserves also drops. As a result, they are less likely to hold dollars in reserve. By diversifying the risk, they move exposure to other currencies, such as the euro, yen and even the Chinese yuan. It reduces the demand for the dollar. This causes further pressure to lower its value.
Starting from the third quarter of 2018, foreign governments had USD 6.6 trillion in reserves in US dollars. This is 62 percent of all allocated reserves of 10.7 trillion dollars. Fall from 66 percent in 2015. This is even less than 63 percent in 2008.
At the same time, the percentage share of the euro in reserves was 20% in 2018. This is less than 27% in 2008. The International Monetary Fund announces this data quarterly in its COFER table.

The growing debt of the United States weighs on the minds of foreign investors. In the long term, they may continue to gradually move away from investments denominated in dollars. This will happen at a slow pace so as not to diminish the value of resources. The best protection for an individual investor is a well diversified portfolio of foreign investment funds.

Trends in the value of the dollar since 2002 Until July 2018

From 2002 to 2011, the dollar has fallen. This applied to all three measures. First of all, investors were afraid of rising US debt. Foreign debt holders are always anxious that the Federal Reserve would allow the dollar to be lowered so that repayment of US debt would be worth less in their own currency. The quantitative easing program of the Fed has monetized debt (the monetization of public debt – the budget deficit – is a modern version of the central bank’s money issue) It can be carried out directly if the central bank lends money to the Ministry of Finance. The government account records the newly created monetary base After the government uses this resource, the entities selling goods and services to the government deposit the money received in their bank accounts, thus the monetary base enters the commercial bank system Creation of the monetary base can also be carried out indirectly – at that time the bank the central office can buy bills of exchange on the open market or carry out rediscounting operations), thus enabling the artificial strengthening of the dollar. This was done to keep interest rates low. After the program ended, investors began to fear that the dollar could weaken.
Secondly, debt puts pressure on the President and Congress to either raise taxes or slow down expenses, which in turn led to sequestration. It limited spending and weakened economic growth.
Third, foreign investors prefer to diversify their portfolios with assets not denominated in dollars.

In 2011-2016, the dollar strengthened. There were six reasons why the dollar has become so strong:

1. Investors are concerned about the Greek debt crisis. This has reduced demand for the euro, the world’s second global currency choice.
2. The European Union fought to increase economic growth through quantitative easing.
3. In 2015, the economic reform slowed China’s growth. It pushed investors back to the US dollar.
4. The dollar is a haven during the global crisis. Investors bought US Treasury securities to avoid risk because the world regained its balance as a result of the financial crisis and recession in 2008.
5. Despite the reforms, both China and Japan continued to buy dollars to control the value of their currencies. It helped them increase their exports, making their export goods cheaper.
6. The Federal Reserve signaled that it would raise the rate of funded funds. They did it in 2015.
Since 2016, the dollar has weakened again. Although the US economy remains strong, investors are concerned about the impact of the Trump administration’s commercial war. At the same time, investors are relieved by the EU’s escape from the sovereign debt crisis in the eurozone.

Rafal Ciepielski

Rafal Ciepielski

CEO RCieSolution

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The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all RCieSolution management teams. Are subject to revision over time.