Investors around the world see the U.S. dollar as weaker than other currencies because of U.S. interest rates near zero and huge budget deficits. That prompts them to trade out of the dollar for riskier, high-yielding assets in equity markets and other countries.
The expectation that interest rates are set to remain low in the U.S. has been a key factor behind the weak dollar and buoyant commodity and stock markets. Investors are betting that policy makers will do little to undermine the strong support for stimulus policies that have done much to fuel global markets and restore risk appetite. They sold the American currency off earlier in the week by expectations that U.S. interest rates will be left low for some time. While the dollar may be gaining strength recently, concerns about the currency persist.
Federal Reserve Bank of Dallas President, Richard Fisher, said he is aware that the Fed's current stance of keeping interest rates low for an extended period was denting the dollar but that he didn't want to do anything about it, pointing out inflation is likely to remain subdued for some time. His comments echoed those of other Fed officials who indicated interest rates are likely to remain low.
On the other hand, Treasury Secretary Timothy Geithner, said Wednesday in Singapore that maintaining a strong dollar is very important for the country's economy and sustaining confidence in its financial system.
Soaring budget deficits, which hit a record $1.4 trillion in fiscal 2009, have also weakened the dollar. The U.S. has borrowed enormously to meet the U.S.'s day-to-day spending needs.
The dollar has declined 16 percent against a basket of six major currencies from the highs set in March and is down more than 37 percent from a peak in 2001.
Developing countries worry that the sinking U.S. currency is making their exports expensive and threatening their fledgling economic recoveries. A lower dollar and China's yuan, which is effectively pegged to the dollar, make other countries' goods relatively more expensive.
While speculation that the dollar is facing sustained devaluation cannot be ruled out, there are good reasons to expect a rally over the next nine to twelve months if the weak dollar helps the U.S. recovery picks up steam.
Positive commodity and stock marketsInvestors are using weak dollar for what's known as carry trade. That means traders borrow cheaper dollars to make other investments such as in emerging-market currencies, commodity or equities. As equity markets continue advancing and investors trade out of the currency for higher returns elsewhere, pressure on dollar amplifies.
The fall in the dollar has pushed gold prices, which closed above $1,100 an ounce for the first time on Nov. 9 and is up 25 so far this year.
The dollar tends to lose value as a result of government stimulus measures or better-than-expected economic reports as investors pursue riskier, high-yielding assets in other countries.
The finance ministers at the 21-member Asia-Pacific Economic Cooperation (APEC) summit in Singapore pledged to maintain government stimulus measures as long as the private sector remains weak. That will prompt a flood of money into developing countries. Many of these countries offer higher interest rates on their securities than the major economies do. But the resulting rise in the value of their currencies makes their exports more expensive.