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Written by H. Bruce Bond and Joe Becker
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Tuesday, 20 October 2009 00:00 |
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Page 1 of 4
 As Americans, the U.S. dollar is an integral part of our daily lives; we use it to facilitate transactions and as a store of value for savings. Yet in spite of this level of familiarity, the dollar is generally given little consideration in terms of its investment potential.
Recently, however, investors have become increasingly aware of the importance of currency as an investable asset class. While much of this interest has focused on single-currency exposures—i.e., taking a long or short position in the euro or yen—advances in indexing, index tracking funds and exchange-traded funds have made more sophisticated currency investments possible as well.1
History Of The Dollar’s Relative Value
When the Bretton Woods international monetary system was dismantled in 1973, the currencies of the 44 participating nations were no longer fettered to the price of gold, and as a result, became free to float against each other.2 This opened the door for investors to potentially benefit from movement in the dollar’s exchange rate.
Figure 1 shows the value of the dollar over time relative to a basket of major currencies. Over the last 35 years, the dollar has been in a general long-term downtrend, albeit one punctuated by periods of enormous volatility.3
This volatility is driven by the many factors that influence currency markets, including interest rates, inflation, balance of trade and economic cycles. Ultimately, of course, the value of the dollar relative to other currencies is determined by supply and demand for the actual currency. Currency values are worked out on a daily basis in the foreign exchange market, which is a decentralized system of buyers and sellers who trade with each other via electronic communication networks.
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