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50 Factors that Affect the Value of the US Dollar

August 8th, 2007

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By Jessica Hupp

Would you believe something as mundane as a rainstorm in New England can
affect the value of the Dollar? It’s true. The US Dollar is subject to numerous
influences, from politics to Walmart, and everything in between. The following
list contains 50 factors that affect the value of the US dollar, both big and
small.

Balance of trade and investment

The balance of trade and investment is often cited by analysts as the most
important influence on the value of the dollar, with good reason. The balance of
trade, related to the current account, represents the difference between what
the US exports and imports in terms of goods and services.

The balance of investment, or financial account, represents the difference in
exports and imports of capital. If exports exceed imports, in either the current
account or financial account, it is called a surplus. When imports exceed
exports, on the other hand, it is referred to as a deficit. The following points
elaborate on how the current account and financial account affect the USD.

Balance of trade: Otherwise known as the current account
balance, the trade balance is equal to the difference between imports and
exports. The US has been running a trade deficit with the rest of the world
for most of recent memory. At $2 billion a day and growing, the trade deficit
is making foreign investors increasingly nervous and can affect the dollar
significantly.

Falling prices on foreign goods: When the prices of
foreign goods decrease, they become more attractive to American consumers,
creating a larger trade deficit. Conversely, a rise in the prices of foreign
goods, through natural price inflation or because or increased demand, can
make American goods look more attractive and help to narrow the trade deficit.
This also supports American industry and the economy. All of this serves to
help the dollar.

Balance of investment: When the US imports more than it
exports, it means investors from other countries have to buy US assets to keep
the dollar from falling. Simply stated, if the US imports more than it
exports, foreign investors must buy dollar-denominated assets like bonds or
treasury securities in order to offset the difference.

Politics

Government policies often have a great impact on the value of the dollar.
Savvy foreign investors know to keep an eye on the state of our political
affairs, especially as they impact the strength of our economy and our ability
to service the national debt.

Budget deficit and national debt: The US government’s
budget can affect the dollar’s value, too. If foreign investors see that the
government is spending more money than it currently has, they know that it
will be forced to borrow from future generations as well as from the private
sector from foreign entities. The US national debt currently stands at $9
trillion and is growing by over $1 billion per day.

Little or no default on debt: When the government keeps a
good credit history, risk goes down and the dollar goes up. Fortunately, the
US is currently considered the world’s most credit-worthy borrower, which in
large part explains why the dollar has remained strong.

President’s popularity: Often, the popularity of the US
president is tied to the value of the dollar. Experts debate whether or not
the two have an effect on each other, but reports point out that “international
investors like to a see a strong U.S. executive because they prefer a single
national decider setting the agenda and fear a fractious, parochial Congress.”

Terrorist attacks and war: Attacks damage consumer and
business confidence, hampering economic growth. They also increase the
likelihood of war, and consequently, a budget deficit to support associated
spending. An ongoing war can quickly become expensive. It makes investors
nervous because it will likely increase our national debt, and slightly
increase the risk of default.

Geopolitical events: Anything that could be seen as
precipitating a conflict or foreign involvement can affect the dollar
negatively. The value isn’t necessarily about what it’s actually worth, but
rather what investors think it’s worth. Perception is often reality in the
forex markets.

Consistent policies: If investors feel that things will
largely stay the same, they’ll flock to the dollar because it’s a safe bet.
This increases demand and thus, the value of the dollar. Remember, unlike many
other investment vehicles, forex is hurt by volatility. This is especially
true with regard to financial policy: if investors believe US policy is on the
right track, they’ll want to put money in dollar-denominated investments.
Conversely, investors can lose faith in an economy that can change with new
policies, so they’ll see the dollar as less of a safe bet.

Government expansion: New departments and increased
government functions cost money, too. Like other government expenses,
expanding or creating new groups like the TSA and the Department of Homeland
Security can lower the dollar’s value due to their opportunity cost against
other expenses in the budget.

Elections: Confidence in or wariness of a new
administration can cause investors to flock to or flee from the dollar. Also,
as new members of Congress are elected, new laws are passed which can affect
our economy. Foreign investors may react positively or negatively to these
changes, affecting the dollar’s value.

Tax cuts for consumers: Tax cuts for consumers fuel
spending, which can improve the economy of our country as well as others, like
China. This can be good for the dollar as long as it does not deepen the trade
deficit or our budget deficit. On the other hand, increases in taxes
discourage personal spending, but they help with government spending and debt.
This can slow the economy, but at the same time lessen our deficits.

Other countries

Political impact on the dollar does not originate entirely from the US; it
can come from all over the world. Trade, conflict, consumption, and other issues
can affect the dollar from outside our country.

Turmoil in other countries: When other countries are in a
state of conflict, their respective currencies may be perceived as unstable.
In this case, investors may flock to the dollar because it is considered a
safer bet.

Stability in other countries: On the other hand, if other
countries are consistent in their policy-making as well as politically and
economically stable, the dollar may weaken because investors have more
confidence in these alternative currencies. They’ll see them as less risky and
diversify into non-dollar denominated assets.

A change in foreign reserves: The USD benefits strongly
from being the world’s reserve currency. Most central banks hold more dollars
than any other currency, but the dollar faces problems when they decide to
diversify their currency investments. This could mean that they sell dollars,
or simply just stop buying more. This is especially damaging when a large
purchaser like China decides to stop adding to its foreign reserves.

A strengthening Euro: The dollar faces competition from
the rising Euro. It’s an attractive alternative to the dollar when investors
choose to diversify or if the dollar becomes unstable.

Acceptance of oil in dollars: As long as the majority of
world oil contracts are settled in USD, other countries have to use the
currency. This increases demand for the dollar and therefore, its value.
Additionally, most oil exporters hold a significant portion of their oil
proceeds in dollars.

Strong foreign economies: If other countries’ economies
are booming, the dollar may fall because it will become a relatively less
attractive place to invest.

Entitlements

As a significant government expense, entitlement programs can have a large
impact on the way investors view the value of the dollar. If it looks like the
US is letting things get out of hand, these programs can shake the confidence of
investors. These are a few of the programs and issues that affect the dollar.

Social Security: It’s apparent to Americans and
foreigners alike that Social Security is a sinking ship that will only get
worse with time. Clearly, this causes investors to lose faith in the US money
management system, but when the US works to reform the program, some of this
confidence is restored and the dollar can benefit.

Medicare/Medicaid: Like other costly entitlements,
government sponsored-health care programs are becoming difficult to maintain,
which could drive investors to seek countries with more stable budgets.

Economic theory

The laws of supply and demand are ever-present in economics, and currency
trading offers a prime example of this law in action. These are a few of the
effects that supply and demand exert on the value of the dollar.

Demand for dollars: This factor can be tied to most
others, but it can function on its own as well. For example,
“if French investors saw an opportunity in the U.S., they might be willing to
pay more francs in order to get dollars to invest in the U.S.” More francs per
dollar means the dollar’s value has risen.

Demand for physical currency outside the US: Some
countries accept dollars as a physical currency, so they need a supply. For example,
“large international demand for US currency bills in the 1990s gave the US
government a unique and inexpensive-to-produce export.” Although it requires
supplying more currency, this is a factor that can strengthen the dollar’s
value.

Increase in money supply: With every new dollar printed,
each one is valued less than before. The more dollars there are in
circulation, the less the currency is valued because the supply has been
increased. In practice, this usually causes inflation, which directly eats
into the value of the dollar. While this would seem difficult to measure, the
Federal Reserve periodically publishes M2 and M3 data reports on the US money
supply.

Interest rates

Just like consumers might shop around for the highest-yielding savings
account, foreign investors look for the best deal in currencies. Here’s how
interest rates affect the dollar’s value.

Rise in interest rates: Higher interest rates mean more
profit for investors, so a US rate hike will generally strengthen the dollar.
In the long-term, however, the law of interest rate parity dictates that
currency valuations and interest rates should move in opposite directions. The
opposite also holds true. If the Fed lowers interest rates, investors might
drop the dollar in the short-term because there’s not enough profit in it.

Attractive interest rates in other countries: Regardless
of whether US interest rates are rising or falling, the dollar’s value also
depends on how US interest rates stack up to those of other countries. If US
rates are lower, investors may switch to different currencies that can offer a
better return. On the other hand, if other currencies have unattractive
interest rates, that allows us to entice investors with a better deal.

News about interest rates: Investors like to be ahead of
the game, so if news of an interest rate hike or fall is released, the dollar
may fluctuate in response to the coming inflow or outflow of investments that
are expected to happen in the future.

American consumers

American consumers have the most at stake in the dollar’s value. A fall in
the dollar makes consumers’ money worth comparatively less, putting a squeeze on
the budgets of the Average Joe. Yet there are several things that consumers do
that serve to drive down the buying power the dollar. Here’s how Americans do
it.

Consumer savings: Americans aren’t big on savings. In
fact, most families have a negative net worth. While this has contributed to a
strong economy in the short-term, it means the US is ill equipped to support
the economy in the long-term. Additionally, negative domestic savings drives
us to import foreign savings, which harms the dollar.

Gas prices: Rising gas prices leave consumers with less
money to spend elsewhere, or worse, drive them to borrow money to keep up
their standard of living.

The Walmart/Honda factor: When Americans buy foreign
goods like items at Walmart or Honda cars, we contribute to an economy that
supports more imports than exports. This creates a trade deficit that weakens
the dollar.

Slow spending: Just as too much spending can hurt the
dollar, too little spending can have a negative effect as well. Analysts report that when we hit a
slow shopping season, “the Fed might see that as a sign of consumer fatigue
and choose to cut rates in an attempt to stimulate growth. That could hurt the
dollar.”

Housing

Recently, we’ve seen how a housing boom and subsequent bust can cause
problems for families, investors and lenders in the form of defaulted loans and
drops in the value of homes. These same issues cause problems for the dollar,
too.

Slow housing market: A slow housing market creates a
domino effect. Sellers are forced to lower their asking prices, which creates
a decline in household spending and results in slowed economy growth, all of
which hurts the dollar.

Strong housing market: A growing, steady housing market
builds the equity and net worth of home owners, spurring spending and growing
our economy. This supports the dollar.

Overinflated housing market: This kind of housing market
results in a fall of equity and personal wealth, but it doesn’t stop there; it
makes the dollar fall as well, as the effect of declining home prices ripples
throughout the economy.

Industry and economic indicators

American industry both affects and reacts to the value of the dollar. When
the dollar falls, our goods become cheaper and more attractive. However, when we
have a strong dollar, our industries have to compete harder against cheaper
foreign labor and goods.

Low growth in manufacturing: Manufacturing levels serve
as an indicator for the health of the US economy. An industry slowdown means a
general slowing in the economy and can cause investors to become wary of the
dollar.

Strong manufacturing growth: Conversely, strong
manufacturing growth can indicate that the economy is picking up, creating a
more attractive dollar.

Outsourcing: Outsourcing creates a trade deficit and
causes US employment to suffer, resulting in a fall of the dollar. However,
outsourcing also makes US companies more profitable and more attractive
targets for foreign investment.

Entrepreneurship: Entrepreneurship creates attractive
investment opportunities for foreign investors, supporting a stronger dollar.

Employment growth: Like manufacturing growth, employment
growth is a good indicator for the overall health of the economy. Positive
employment growth will attract more investors and create a stronger dollar.
Unnaturally high unemployment causes the dollar to drop because the government
loses tax revenue that could help with the deficit. It also takes consumer
purchasing power away, which causes the economy to suffer.

Wage data: Higher or lower wages can either attract or
scare off investors, creating a fluctuation in the dollar’s value.

US capital markets

US stocks, bonds, and other investments can be appealing no matter where you
are in the world. The performance of US capital markets can either attract or
reduce foreign investment, which directly affects the dollar.

Bear markets: Falling values create investment losses
that shake investor confidence and cause them to diversify or liquidate their
portfolios, resulting in a loss for the dollar if the diversification involves
an exodus from dollar-denominated assets.

Bull markets: Strong market values have the opposite
effect, creating profits that attract new investors and encourage current
investors to put more money into dollar-denominated assets. A booming market
can attract investors, but it can also cause the dollar to fall when it
corrects itself and investors pull out.

Accounting scandals: Accounting scandals like Enron can
burn investors and cause foreign investment in US stocks to fall.

Economy

The current performance of the US economy is synonymous with the financial
health of our nation. It signals to investors our ability to pay back debts as
well as the profit level they may earn.

Economic growth and stability: In general, a strong
economy will raise confidence, assuring foreign investors that they’ll earn a
good profit on a stable investment. Economic growth is even better, attracting
investors who hope that their investment will grow, too. A boom in the economy
can cause an investment rush that results in a temporary overvalue of the
market. This can lead to a dollar loss when it corrects itself in a slow of
the economy.

Economic recession: What goes up must come down. A
slowing economy hurts the dollar, causing investors to pull out for fear that
their investment will lose value.

Outperforming other economies: Economic performance is
all relative. If the US economy is stronger than others, investors may turn to
the dollar as a safe bet.

Weather

Weather affects the agricultural industry, energy consumption, and local
economies. Any change, for better or for worse, can create a ripple affect that
impacts the economy as a whole and causes the dollar to fluctuate.

Unfavorable farming conditions: Unfavorable farming
conditions can result in slow crops and force grocers to turn to other
countries to satisfy US agricultural needs. This further opens up the trade
deficit and weakens the dollar.

Unusually hot summers: An unusually hot summer can cause
a rise in energy costs for both consumers and industries. This can create a
strain on the economy and cause the dollar to fall. Just like an unusually hot
summer can sink the dollar, an excessively cold winter can do the same thing.
It can cause energy costs to rise, and since must of our energy is imported,
the dollar may be adversely affected. Additionally, consumers will presumably
have less disposable income to pour into other areas of the economy.

Natural disasters: Natural disasters like Hurricane
Katrina create a strain on local economies as well as the local and federal
government as we work to repair damage and spend money on relief and
rebuilding. This can cause the dollar to struggle.

Inflation

Inflation directly eats into the value of the dollar. The law of purchasing
power parity (PPP) holds that a nation’s currency and its general price levels
should move in opposite directions.

Slow in inflation of foreign goods: A slow in inflation
of foreign goods keeps prices of those goods steady, allowing American
consumers to purchase the same amount or more of the same goods. This does not
help to close the trade deficit and can weaken the dollar.

News about inflation: Of course, any news about possible
inflation of the dollar or foreign goods can cause the foreign exchange market
to react preemptively and fluctuate the dollar one way or another.

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Posted: August 8th, 2007 in Features

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