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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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