Value is not necessarily about actual worth, but much more about expectations of worth. This notion holds true whether valuing a stock or the dollar. Dollar valuation includes the purchasing power now and in the future and the value relative to other countries.
Changes within the Consumer Price Index (CPI) reflect purchasing power and exchange rates measure the value of the dollar over other currencies. The U.S. dollar is the most traded dollar in the world, accounting for 80% of all trades.
There are a number of factors that affect its expectations of worth, including balance of trade and investments, political climate, economic indicates of foreign countries, the overall economy and U.S. capital markets, inflation and interest rates. The two most influential factors include the current trade deficit and interest rates.
As the trade deficit increases, more dollars leave the country and its value decreases. The United States is operating under a trade deficit, thus, the country imports more than it exports. When the trade deficit rises or falls, the dollar’s value falls or rises, respectively.
Interest rate expectations are the number one currency price mover for the past 10 years. Global investors move their money to countries with high or rising interest rates. The rise in unemployment rate, production and inflation are economic indicators that lead to higher interest rates and a stronger currency.
Higher interest rates are more profitable to investors until the law of interest rate parity is incorporated. In the long term the value of the dollar and interest rates move in opposite directions.
The government intervention at the beginning of the financial crisis prevented a financial meltdown, but government also is a factor in rising interest rates and inflation woes. The government increased spending at the expense of the national debt and deficit.
Loose monetary policy is leading to decreases in the value of the dollar. The near-term shows further weakening of the dollar, but the dollar should eventually stabilize in the long term. Like market expectations, however, future sentiments of the dollar are uncertain.