Overview, Knowing the US Dollar, How To Read US Economy

Knowing the US Dollar

Security Concerns

The Terrorism incidents of 11th September 2001 have had a severe impact on an otherwise strong US Dollar. Prior to that fateful day, most of the countries in the world held their currency reserves in the USD at a marginally less interest rate because the US was considered to be the safest country when it comes to Terrorism. But, that changed after those incidents and many countries have divided their portfolio, sharing it with other currencies like the Euro or the GB Pound.

Volume of Trade

Undisputedly, the US Dollar ranks number one in terms of volume of global currency trade. Majority of world currency dealings (about 91%) are in terms of the US Dollar, and any change in the position of the Dollar is bound to have an impact on most of the other world currencies indirectly. Hence, it is highly expedient for a foreign exchange investor to follow the US Dollar closely.

Gold and the US Dollar: The Relationship

During the downturn of the US economy after Sept'11 2001, the US Dollar depreciated considerably whereas Gold kept on appreciating. The reason is simple: Gold is measured in Dollars. Hence, when the Dollar was found to be vulnerable, people still exuded confidence in the yellow metal because it is considered to be the 'measure of value'. This leads to an inverse relationship between Gold and the US Dollar; the Dollar rises when Gold falls and vice versa.

US Dollar and currencies of developing economies

Growth in Import and Export of any country with the US depends strongly on the conversion rate of their local currencies with the US Dollar. An appreciating Dollar promotes exports to the US, while an appreciating local currency tends to promote imports from the US into the country. Most governments of such countries control their currencies within a small range of the US Dollar with the aim of stabilizing the Import and Export activities. This done by purchase or sale of the US Dollar as warranted by the situation. Examples of this are China, India & Mexico. This is also called "pegging" of the local currency to the US Dollar. Surprisingly, these countries also favour a Strong Dollar, which coincidentally works out to the liking of the US Federal Reserve.

Rate of Return: US and Foreign Assets

Foreign Investors would stay put to their US assets (fixed or otherwise) only if the return on their investments is higher than that offered by opportunities at home or any other foreign country. Any indication of a diminishing rate of return from US assets would persuade foreign investors from selling their assets and parking their funds elsewhere. This would involve selling US Dollars and buying foreign currencies which means that the demand for the Dollar would reduce. That would lead to the depreciation of the dollar.

The US Dollar Index

This is a measure of the strength or weakness of the US Dollar. The geometric average (with trade weights) of six currencies is calculated to obtain the US Dollar Index. One needs to follow this Index on a daily (or rather hourly) basis to know the current standing of the USD vis-a-vis other currencies.

Influence of Stock markets on USD

The Equity trading in Stock markets is one of the most important parameters to influence the US Dollar. If the US Stock markets are doing well, the foreign investors would be attracted to buy US Stock options, for which the Dollar would be in demand. This would strengthen the Dollar, and in a significant manner as the volumes involved are quite huge. Conversely, if there is a downtrend in the US Stock markets, the dollar would lose its demand, thereby becoming weak in the process. In a nutshell, Stock markets influence the US Dollar in a big way because all Foreign investments involve conversion of foreign currencies into the USD.

Overview, Knowing the US Dollar, How To Read US Economy