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.
