The U.S. Dollar has had quite a ride during the last two years.  The 2008 Crisis has caused huge waves of volatility to move through financial markets, and the foreign-exchange market in particular.  In this article we will examine the role of the U.S. Dollar in the global economy, and by examining how it has performed over the last two years during various market cycles, we may gain a better idea of where it is headed in the days and years to come.

In order to really understand the value of the U.S. Dollar, one must have a basic grasp of interest rate theory in relation to currencies.  Each currency in the world has an interest attached to it that is set by its Central Bank.  The manipulation of this interest rate increases and decreases the supply of a currency in the economy and therefore will either stimulate or tighten economic activity.  During the 2000’s, Fed Chairman Alan Greenspan kept U.S. interest rates at very low levels versus other industrialized nations around the world such as England, Australia, and the EuroZone.  These low interest rates in the U.S. led investors to flee from the U.S. Dollar in search of higher yielding currencies, which resulted in a very bearish U.S. Dollar run.  In this picture of the Euro, you can see the dramatic fall of the U.S. Dollar throughout the 2000’s.

In 2008, when the Global Credit Crisis really exploded in September of ’08, the currency market went crazy.  There was a mad rush into the U.S. Dollars as unprecedented fear caused investors to demand the safety of their capital above everything else.  From September of 2008 to March of 2009, the U.S. Dollar experienced a dramatic rise in value versus the Euro, Pound, and nearly very currency in the developed world.  The reason is because in times of complete uncertainty, the U.S. Dollar is the safest place to park capital.  Investors want assurance that their investment is safe, so they opt to place capital in low yielding but very safe investment vehicles such as U.S. Treasuries.

In March of 2009, the recession bottomed out.  Economic growth resumed in the developed world and it looked as though the worst was behind us, so investors began taking their money out of the safe, but very low-yielding U.S. Dollar and placing it in riskier currencies that were offering higher risk.  Thus, began another round of Dollar weakness.  Let’s take a look at another Euro chart.

The U.S. Dollar was very weak throughout the 2^nd and 3^rd quarters of 2009.  Then, in November of 2009, the Greek Debt Crisis erupted and send financial markets into a tailspin yet again.  Investor sentiment weakened around the world, and there was another mad rush into the safety of the U.S. Dollar.  The Dollar rallied significantly against the Euro from November of 2009 until June of 2010.

Once the European Central Bank finally stepped in to pledge bailout funds for Greece and other struggling EuroZone countries, investors again began to sell the U.S. Dollar in search of higher yield and the Dollar began to fall versus every currency pair.

This phenomenon of the U.S. Dollar doing well only during times of economic distress could be a long-term sign of bad things to come.  Currently, the only reason investors want to hold the U.S. Dollar is for safety.  There is no interest in it as an investment.  What will happen if the U.S. loses its place as a harbor of safety?  Investors already want nothing to do with the Dollar during good times.  What if they don’t during bad times either?  That could spell disaster for the U.S. Dollar.  A forex demo account can teach you how to take advantage of the volatility in the  FX Market.

Popularity: 3% [?]