The value of the U.S. dollar is measured in three ways: exchange rates, Treasury notes, and foreign exchange reserves.
While the most common method is through exchange rates, the truth is you need to be familiar with all three in order to make educated guesses about where the dollar might be headed next.
The dollar exchange rate compares its value to the currencies of other countries. It allows you to determine how much of a particular currency you can exchange for a dollar. The most popular exchange rate measurement is the U.S. Dollar Index.
These rates change every day because currencies are traded on the foreign exchange ("forex") market. A currency's forex value depends on several factors, including:
- Central bank interest rates
- The country's debt levels
- The strength of the economy
When these factors are strong, so is the value of the currency. Most countries have a flexible exchange rate and allow forex trading to determine the value of their currencies.
The Federal Reserve has many monetary tools that can influence the strength of the dollar. These tools allow the government to regulate exchange rates, albeit indirectly.
The U.S. dollar rate shows the value of the dollar in comparison to other currencies, including the Indian rupee, Japanese yen, Canadian dollar, and the British pound. Below, you can track the dollar's value as measured by the euro since 2002.
This chronology explains some of the dollar's changes in value over the years:
- 2002-07: The dollar fell by 40% as the U.S. debt grew by 60%. In 2002, a euro was worth $0.87 versus $1.46 in December 2007.
- 2008: The dollar strengthened early in the global financial crisis, thanks to its position as a "safe haven" for many investors, among other factors. By year’s end, the euro was worth $1.35.
- 2009: The dollar fell by 20% thanks to debt fears. By December, the euro was worth $1.46.
- 2010: The Greek debt crisis hurt the euro and strengthened the dollar. By year’s end, the euro was only worth $1.32.
- 2011: The dollar's value against the euro fell by 10%. It later regained ground. As of December 30, 2011, the euro was again worth $1.32.
- 2012: By the end of 2012, the euro still hovered around $1.32.
- 2013: The dollar lost value against the euro, as it appeared at first that the European Union was, at last, solving the eurozone crisis. By December, it was worth $1.37.
- 2014: The euro-to-dollar exchange rate fell to $1.23 thanks to investors fleeing the euro.
- 2015: The euro-to-dollar exchange rate fell to a low of $1.12 in March. It later fell to $1.05 after the Paris attacks in November, before ending the year at $1.08.
- 2016: The euro rose to $1.13 on February 11 as the Dow fell into a stock market correction. It fell further to $1.11 on June 25, just two days after the United Kingdom voted to leave the European Union. Traders thought uncertainty surrounding the vote would weaken the European economy. Later on, the markets calmed down after realizing that Brexit would take years. It allowed the euro to rise to $1.12 in August. Not long after, the euro fell to its 2016 low of $1.04 on December 20, 2016.
- 2017: By May, the euro had risen to $1.10. Investors left the dollar for the euro amid allegations of connections between President Trump's administration and Russia, along with concerns about the new administration's ability to fulfill its agenda. By the end of the year, the euro had risen to $1.18.
- 2018: The euro continued its ascent. On February 15, it was $1.25. In April, the euro began weakening after President Trump initiated a trade war. By end of the year, the euro was $1.14.
- 2019: The euro declined until September when it reached $1.10. It rose briefly in December to $1.11.
- 2020: The euro strengthened against the dollar throughout the first year of the COVID-19 pandemic, reaching $1.22 by December.
Exchange rates are just one factor in the dollar's value, however—the dollar also moves in sync with the demand for Treasury notes. The U.S. Department of the Treasury 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 then they can resell them on a secondary market.
High demand means investors pay more than face value and accept a lower yield, while low demand means investors pay less than face value and receive a higher yield. A high yield means low dollar demand until the yield goes high enough to trigger renewed dollar demand.
Before April 2008, the yield on the benchmark 10-year Treasury note stayed in a range of 3.34% to 3.91%. That indicated a stable dollar demand as a world currency.
Here are some of the Treasury note events over the past decade-plus that impacted the dollar's value:
- 2008: The 10-year Treasury note yield dropped from 3.57% to 2.91% between April 2008 and March 2009 as the dollar rose. Remember, a falling yield means a rising demand for Treasurys and dollars.
- 2009: The dollar fell as the yield rose from a low of 2.23% to a high of 3.85% by the end of the year.
- 2010: From January 1 to October 10, the dollar strengthened as the yield fell from 3.85% to 2.41%. It then weakened due to inflation fears from the Fed's quantitative easing strategy.
- 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. It rose to 3.75% in February then plummeted to 1.89% by December 30.
- 2012: The dollar strengthened significantly, as the yield fell in June to 1.47%, a 200-year low. The dollar weakened toward the end of the year, as the yield rose to 1.78%.
- 2013: The dollar weakened slightly as the yield on the 10-year Treasury rose from 1.86% in January to 3.04% by the end of the year.
- 2014: The dollar strengthened through the year, as the yield on the 10-year Treasury fell from 3% in January to 2.17% by year-end.
- 2015: The dollar strengthened in January, as the 10-year Treasury yield fell from 2.12% in January to 1.68% in February. The dollar weakened for the remainder of the year as the yield rose to 2.28% in May and ended the year at 2.27%.
- 2016: The dollar strengthened as the yield fell to 1.37% on July 8, 2016. The dollar weakened as the yield rose to 2.45% at year-end.
- 2017: The dollar weakened as the yield hit a peak of 2.62% on March 13, then grew stronger as the yield fell to 2.05% on September 7. The yield rose to 2.49% on December 20, ending the year at 2.4%.
- 2018: The dollar continued weakening. By February 15, the yield on the 10-year note was 2.9%. Investors were worried about the return of inflation. The yield remained in this range, rising to 3.09% on May 16 then falling to 2.69% by December.
- 2019: The dollar weakened as the 10-year yield peaked at 2.79% on January 18. But on March 22, 2019, the yield curve inverted. The 10-year yield fell 2.44%, below the three-month yield of 2.46%. That meant investors were more worried about the U.S. economy in three months than in 10 years, a sign they were concerned about recession. The yield curve recovered, then inverted again in May. On August 12, the 10-year yield hit a three-year low of 1.65%. That was below the one-year note yield of 1.75%. It fell to a low of 1.47% on Sept. 4. Although the dollar was strengthening, it was due to a flight to safety as investors rushed to Treasurys. By the end of the year, it had risen to 1.92%.
- 2020: The dollar weakened and Treasurys plunged in the spring of 2020, starting the year at 1.88% for the 10-year yield and diving 0.62% by early April as the COVID-19 pandemic set in. Yields for all types of Treasurys took a steep dive, indicating widespread recession fears, but the shortest-term yields were hit the hardest—suggesting that investors felt that 2020 would be a particularly tough year. The one-month, two-month, and three-month yields dropped all the way from just over 1.5% at the beginning of the year to zero on March 25, before starting to reclaim some value the next month.
Foreign Currency Reserves
The dollar is held by foreign governments in their currency reserves, which is the third factor affecting its value. They wind up stockpiling dollars as they export more than they import and receive dollars in payment. Many of these countries find that 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 other countries' reserves also decreases. As a result, they are less willing to hold dollars in reserve. They diversify into other currencies, such as the euro, yen, or even the Chinese yuan. This reduces the demand for the dollar, putting further downward pressure on its value.
As of the third quarter of 2020, foreign governments held $6.94 trillion in U.S. dollar reserves. That's 60% of the total allocated reserves of $12.25 trillion. It's down from a height of 66% held in 2015. It's even less than the 63% held in 2008.
At the same time, the percentage of euros held in reserves was 20%. That's less than the 27% held in 2008. Banks only held 2% of their reserves in Chinese renminbi.
How the Dollar Impacts the US Economy
When the dollar strengthens, it makes American-made goods more expensive and less competitive compared to foreign-produced goods. This reduces U.S. exports and slows economic growth. It also leads to lower oil prices, as oil is transacted in dollars. Whenever the dollar strengthens, oil-producing countries can relax the price of oil because the 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 by 20% against the euro, the value of the riyal, which is fixed to the dollar, has also risen by 20% against the euro. To purchase French pastries, the Saudis can now pay less than they did before the dollar became stronger. That's why the Saudis didn't need to limit supply as oil prices fell to $30 a barrel in 2015.
The value of money ultimately equals the total amount of commodities you can purchase with your funds at a given time. When prices for food or gas rise, your money’s value shrinks because a given amount can now buy less than what it used to.
The Value of the Dollar Over Time
The dollar's value can also be compared to what could have been bought in the United States in the past. Today's dollar value is much less than that of the past because of inflation.
The growing U.S. debt weighs on the minds of foreign investors. In the long-term, they may continue—little by little—to move out of dollar-denominated investments. It will happen at a slow pace so that 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.
Dollar Trends 2002-2011: Decline
From 2002 to 2011, the dollar declined. This was true with all three measures for three principal reasons that built off each other: growing U.S. debt, sequestration, and worldwide diversification.
Growing US Debt
Investors were concerned about the growth of the U.S. debt. Foreign holders of this debt are always uneasy that the Federal Reserve would allow the dollar's value to decline so that U.S. debt repayments would be worth less in their own currency. The Fed's quantitative easing program monetized the debt, thereby allowing an artificial strengthening of the dollar. This was done to keep interest rates low. Once the program ended, investors grew concerned that the dollar could weaken.
The debt put pressure on the president and Congress to either raise taxes or slow down spending. This led to sequestration, which restricted spending and dampened economic growth. Investors were sent to chase higher returns in other countries.
The growing debt and subsequent sequestration led to concern among foreign investors that the dollar wasn't quite as reliable, and that therefore they would need to diversify their portfolios with non-dollar-denominated assets. This added to the downward pressure on the dollar.
Dollar Trends 2011-2016: Strengthening
Between 2011 and 2016, the dollar strengthened. There were six factors that combined to make the dollar become much stronger after years of declines:
- Investors worried about the Greek debt crisis. It weakened demand for the euro, the world's second choice for a global currency.
- The European Union struggled to boost economic growth through quantitative easing.
- In 2015, economic reform slowed China's growth. It pushed investors back into the U.S. dollar.
- The dollar is a haven during any global crisis. Investors bought U.S. Treasurys to avoid risk as the world recovered unevenly from the 2008 financial crisis and recession.
- Despite reforms, both China and Japan continued to purchase dollars to control the value of their currencies. It helped them boost exports by making them cheaper.
Dollar Trends 2016-2020: Fluctuations Amid Uncertainty
Recent years have resulted in some instability in the dollar's value as uncertainty increased around the globe with President Trump taking office in 2016, and then the 2020 recession.
Between 2016 and 2020, the dollar started to weaken again as the aforementioned global events propping it up faded into the past and concerns about the impact of the Trump administration's trade war began to weigh on investors. In 2019 and into 2020, it strengthened as investors sought safety amid concerns about a looming global recession, but eventually sank as the economy dealt with the effects of the pandemic.