How the Dollar has changed in the 21st century

The 21st century has brought new developments to the valuation and purchasing strength of the United States Dollar. Moreover, the dollar has declined in value in two ways. First, the domestic spending parity with goods and services has declined, and second, the dollars' valuation against foreign currencies not pegged to the dollar has declined. To illustrate, with increases in the consumer price index (CPI), an inflationary metric, a dollar will be able to buy less of what it could once purchase more of.

Image source: Przemyslaw Wojtkowski

Inflationary pressures such as increases in the cost of groceries such as milk and eggs, and transportation expenses are examples of variables within the CPI inflation measurement. In terms of valuation against foreign currencies, the dollar has also decline in value. For example, the Canadian dollar used to be valued significantly lower than the U.S. dollar while in 2007 and 2008 the Canadian dollar was valued at close to par with the U.S. dollar, sometimes higher than the U.S. dollar.

Causes of fluctuation in currency value

There are several reasons why currencies fluctuate in value. The causes in daily fluctuations are sometimes due to different reasons than longer-term changes in currency valuation. Essentially, but not in all cases, the more factors that influence a currency downward are present, the lower the valuation of the currency will go in terms of value in terms of foreign currency. In regard to purchasing power a similar correlation may be drawn. Moreover, when currency value declines, inflation protection is often necessary to preserve wealth. A few of the factors that influence the price of currency are listed bellow, several of which are influenced by monetary policy implemented by the Federal Reserve Bank.

• International confidence in the dollar
• Leveraged FOREX market movements
• Inflationary pressure
• Political developments
• Economic indicators
• Liquidity or Money Supply 
• Interest rates
• Commercial Market Conditions
• Global cash flow developments
• Return on Dollar Investments

Possible solutions to increasing the Dollar's value

Deciding what needs to be done to stabilize the value of the dollar and lower the inflationary pressure that affects purchasing power of the dollar is a multifaceted issue. The reason it is multi-faceted is due to all the influencing factors mentioned above. Changing just one variable is less likely to have a great impact on the value and strength of the dollar than transforming more than one or several variables. In other words, if U.S. Investments were to yield a higher profit in relation to other global investments and the economic stability and/or growth of the United States economy were to become more favorable, then the chances the dollar would rise in value would have a greater chance  had only the returns on investments in relation to foreign investments risen.

Currency valuation and purchasing strength is an indicator of domestic and global economic conditions, inflationary factors, and international investment confidence. When globalization began to accelerate, the United States was no longer the only place in the world that provided solid returns and stability to foreign investors. The emergence of global economic blocks such as the Euro zone, and Southeast Asia made investments in U.S. Government backed securities a less important option than other global investment vehicles. While this trend has become disturbing to economists, citizens and some politicians, the dollar continues to attract foreign investment, the trade deficit had declined, and the U.S. economy remains relatively stable despite an extended period of slowed growth and downward pressure on its value from monetary policy.

Summary

In some senses fear over the decline of the U.S. Dollar is justified while in other ways it is not. While some conditions that have led to the decline do warrant remedy and action, the situation may not be as dire as some believe. This is so as the United States remains the largest if not among the largest economies of the World and for good reason. Vast natural resources, a developed securities market, a massive economic infrastructure, internal political stability, commercially favorable regulatory environment and lower taxes than in the Euro zone still make the United States a great economy.

The U.S. Government is now facing large decisions as health care, security, infrastructure, international debt obligations and other expenditures outweigh cash inflow. These financial issues are likely to be addressed in one way or another in addition to the possibility of being buoyed by favorable industrial and commercial developments within sectors of the economy that allow innovation and product development to make the American economy the leader it has been and will probably continue to be for some time to come.

What is currency manipulation?

Currency manipulation is the influencing of currency valuations in proportion to the value of other currencies, and in terms of trading price bid ask spreads which is the difference between selling and asking price of a currency pair. Currencies change in value daily based on market conditions and foreign exchange transactions. However, these changes can be manipulated directly or indirectly through governmental decision-making, monetary policy and institutional market based strategy.

Both the United States and China have been accused of manipulating their currency in recent times. More specifically, China limits how much its currency, the Yuan-Renminbi, appreciates in value only allows it i.e. the Yuan-Renminbi to fluctuate a certain amount in value thereby influencing both national currency, Gross Domestic Product and trade balance. 

In the case of the United States, monetary policy that significantly affects currency value has been considered a direct effort to debase the dollar. However, U.S. officials such as Treasury Secretary, Timothy Geithner have denied this claim stating that a devalued currency is not the intention of liquidity, but rather a bi-product of economic stimulus.

The above examples are indicative of trends within currency wars. This occurs when multiple nation-states are believed to be in competition against each other via the price of their currency. A potential consequence of global currency manipulation that motivates the currency war in the first place is economic strength linked to high exports. 

Since exports often increase when the prices of goods and services are cheaper, the advantages of a lower valued currency can be profound. Thus, currency manipulation may be more likely during periods of global economic struggle rather than prosperity. Countries may compete for lower currency prices by either directly pegging their currency to another via political means, or by altering the money supply through monetary policy.

Financial institutions may also manipulate currency by trading both ends of currency transactions and betting ahead of the market. For example, ABC Financial Intermediary is a financial institution that facilitates foreign exchange for individual clients. Via this information, and with direct access to large amounts of financial leverage, company's can essentially see what is going to happen in a market before it actually happens and make currency trades that allow them to be profitable, and limit the movement of currency prices to their advantages. This is more likely to be the case with unregulated foreign exchange brokers which is a potential pre-cursor to currency manipulation.

Enforcement of currency manipulation is sometimes weak according to the Congressional Research Service. This is because large international financial institutions do not always have the power to require countries to alter their national monetary policy. Similarly, the Congressional Research Service also state the World Bank, another large global financial intermediary does not have a large scope of authority in terms of subsidizing specific goods that in effect has a similar function as devalued currency. Since nation-states are sovereign entities, collaboration and agreement regarding monetary policy may be one of the few effective ways to avoid national currency manipulation.

Sources: 

1. http://bit.ly/c2iLL5 (Congressional Research Service)
2. http://bit.ly/bP5dIO (Yahoo Finance)
3. http://bit.ly/9qQRyn (National Futures Association)