Factors Driving the Value of the United States Dollar

The decision to either buy or sell U.S. dollars is based on the economy’s performance. Investment from all corners of the world flows in, and is directed into a strong economy. Investors see the U.S.’s safety, and they recognize their ability to achieve a reasonable rate of return on their money. These people invariably seek the highest possible “safe and predictable” yield. Increased investment from offshore accounts creates a strong capital account, which, in turn, creates a demand for U.S. dollars.

Conversely, when consumer consumption results in the importation of goods and services from abroad, dollars flow out of the country. When imports become greater than exports, there is a deficit in the nation’s current account. With a strong economy, the trade deficit can be offset by the attraction of foreign capital. Even though the United States is a debtor nation, it continues with its role as the consumption engine that fuels the world’s economies. U.S. consumption provides other countries with the opportunity to export products to the U.S., which, in turn, maintains the dynamics of their economies.

Three factors impact the value of the dollar, factors that determine the currency’s direction or trend. They are:

• Factors affecting supply and demand

• Market sentiment, and

• Technical factors

Factors Affecting Supply and Demand

When products or services are exported, there is a demand for dollars. Foreign buyers must pay for their purchases in U.S. dollars. To do this, they convert their local currency into dollars to satisfy payment. Also, when large U.S. corporations or the government issue bonds to raise additional capital, purchases made by foreign entities must be paid for in dollars.

These are but two examples that show how the United States creates a demand for dollars. An increase in demand puts pressure on supply, which, in turn, drives up the value of the currency relative to the money that is sold to buy dollars. The U.S. dollar is seen as a “safe haven” currency during times of uncertainty. The demand for U.S. dollars persists despite performance fluctuations in the economy.

Market Sentiment

Should the U.S. economy weaken and consumer consumption begins to slow, the U.S. is confronted with the real possibility of a sell-off. This could conceivably come from a return of the monies from the sale of bonds. When foreign investors repurchase in their currency, the effect is dampening demand for the dollar.

Technical Factors

Traders must gauge whether the dollar supply will be more or less than the demand for the currency. To help determine the trend, traders pay very close attention to events or news that may impact the dollar’s value. The factors include such things as payroll data, GDP data, and other factors that influence consumer confidence.

In addition to local factors, the views of others, such as asset managers and investment banks, must be considered. Sentiment drives the market, sometimes more than economic fundamentals. In addition, traders must constantly analyze historical trends and patterns, such as resistance and support levels.

Bringing it all Together

Buy-sell decisions are usually made based on some combination of factors. During the 2007 recession, the government was pulled into taking an unprecedented role in the economy. Because the economy was receding due to the deleveraging of assets, the government was forced to “pick up the slack.” This was done by increasing spending in an effort to prop up the economy, which in turn created employment opportunities which lead full circle to an increase in consumer consumption.