The Value of a Dollar

The value of the dollar is not set by our government, or by any other government or group of governments; it is set by the demand for U.S. dollars and that is determined by the demand for American products or services American dollars are needed to pay for them. Comparing the first nine months of last year to 2013, the increase in American net imports of goods and services was negligible (stronger exports of corn and crude oil accounted for a good share of that increase). Therefore, the main reason people from other countries have been buying U.S. dollars is for investment purposes.

The value of the dollar is determined in comparison to other currencies. How would we protect the measurement from the problems inherent in the value of other currencies? What most observers use is what is called a “trade-weighted average” where they identify the countries with which the United States trades the most to understand the purchasing power of the dollar. In rough numbers, these are the main countries trading with the United States for the first nine months of 2014:

• Canada — 17 percent
• China — 14 percent
• Mexico — 14 percent
• Eurozone — 12 percent
• Japan — 5 percent
• S. Korea — 3 percent
• United Kingdom — 3 percent

So the buying power of those currencies in those proportions are compared to the dollar and the result is the relative strength of the American currency.
A strong dollar makes our exports more expensive for buyers in other countries, makes American travel more expensive for foreign tourists and makes imports less expensive--all of these consequences tend to shift the value of the dollar back down. But, importantly, when the cost of so many imported things we buy goes down, particularly oil, that relative decline in the cost of living eases inflationary pressure. That is a crucial pressure in a country where the Fed says it wants a rise in inflation.