The U.S. dollar rate tells you the dollar’s value compared to another currency. The U.S. dollar is the world’s reserve currency. That means most businesses, government officials and travelers around the world need to know the exchange rate between their own currencies and the dollar. That’s especially important for contracts that are priced in the dollar, such as gold and oil. Almost half of the world’s international transactions are denominated in dollars.
U.S. travelers need to know the current dollar value before they go on an international trip. Even though most foreign businesses take dollars if necessary, they charge a fee. Did you know that the cheapest dollar rate is with your credit card? So, pay for almost everything you can with your card to get the best rate. You can even find cards that don’t charge an international transaction fee.
The dollar rate is of vital interest to foreign exchange traders. Most of these work for businesses that seek to hedge their exposure to foreign currency volatility. This risk occurs when businesses trade internationally. They either get their supplies from other countries or export to foreign markets. Many also have offices or plants overseas. Hedging allows them to protect these transactions from exchange rate changes that could damage their profitability.
The fastest growing group of forex traders seek to profit from the currency trade alone. One way is to buy a currency that they think will appreciate against the dollar. Once the currency grows in value, they trade it back for more dollars than they paid for it. When enough traders think a currency will rise, that increases demand and forces the currency’s value up. It can also force the dollar to decline.
They also borrow in a currency that charges low interest rates, then invest in a currency that pays high-interest rates. For years, many traders did this with yen. This was known as the yen carry trade. The Bank of Japan encouraged this, because it kept the value of the yen low. This allowed Japanese manufacturers to competitively price their exports.
Four Factors That Affect It
Four factors affect the dollar rate. The first is the law of supply and demand. Since the dollar is the world’s reserve currency, it’s automatically in higher demand than other currencies. This has allowed the United State to sell a lot more Treasury notes. It can increase supply, without suffering from higher interest rates. As a result of this increased fiscal stimulus, the U.S. economy was very strong until the 2008 financial crisis.
The second factor is the strength of the U.S. economy. It’s considered the most powerful in the world. That’s why the dollar rate actually strengthens during any global crisis. Even though decisions made in the United States caused the financial crisis, investors flocked to the dollar because it was seen as a safe haven. The same thing happened in the summer of 2001 and 2012, as investors fled from the euro during the eurozone debt crisis.
A third factor that affects the dollar rate is the interest rate paid on U.S. Treasurys. Usually, the lower the interest rate paid, the less demand. The U.S. dollar is a safe haven in an uncertain world. That allows the U.S. Treasury to pay a low interest rate and still receive high bid prices. That allows the United States to run a larger debt. Other countries must pay higher yields to renew their debt.
The fourth factor is the large U.S. debt-to-GDP ratio. That would normally reduce the dollar rate. Until the financial crisis, the more the debt grew, the faster the dollar’s value fell. But this is not as much an impact as long as the dollar is being treated like a safe haven.