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Old 06-06-2008, 11:58 AM   #1 (permalink)
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Determining the Fate of the US Dollar Part III

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In our last lesson we finished up our discussion on the most important factor which will determine the fate of the US Dollar, its status as the reserve currency of the world. In today's lesson we are going to wrap up our discussion on the fate of the US Dollar, with a look at the other three factors traders watch when analyzing the long term fate of the dollar.

If you remember from our first lesson on "Why the US Dollar is Still King of the Currency World", we listed 4 main contributing factors. As we just discussed, the most important factor is its status as the world's reserve currency. Next in line in importance, is the fact that so many foreigners invest in US Assets, and/or hold their savings in US Dollars. According to Kathy Lien's book Day Trading the Currency Market "Foreign direct Investments into the United States are equal to approximately 40% of total global net inflows for the US. On a net basis, the US absorbs 71% of total foreign savings." This is a huge amount of money being held in US Dollars, to the point where foreign individuals and institutions taken together, have enormous control over the fate of the US Dollar.

With this in mind, there are several things that traders watch for when trying to detect any change, which would affect foreigners appetite for US assets, and/or the US Dollar. As individuals and corporations have many of the same concerns that a central bank has in holding US Dollars, we have already covered most of the factors that will affect private individuals and institutions appetite for the dollar. These are things like return on their investments (so basically stock market performance and bond yields), anything they feel may affect those returns (things such as monetary policy and general economic soundness), and the relative value of the dollar itself.

One factor which we have not discussed yet is the general stability of the United States. Before September 11th, the US Dollar was considered a safe haven currency, which would strengthen in times of global uncertainty, as the US was considered one of the safest and most stable places in the world. The events of September 11th diminished the US Dollar's status as a safe haven currency some what, a status which it has struggled to regain ever since.

Next in line of importance is the US Dollar's role in international trade. Many commodities such as gold and oil are quoted in US Dollars in the international markets, and because of this many countries use the US Dollar in international transactions. As we discussed in our lesson on why the US Dollar is Still the King of the Currency world, this creates a lot of demand for the US Dollar, which helps keep foreigner's appetite for the currency strong. As a result, traders are very wary of any talk from countries outside the US, about moving away from the dollar as the de facto currency for international transactions. This is especially true about countries that are a part of OPEC, the oil cartel made up primarily of the oil producing countries in the Middle East.

We should now have a good understanding of each of the factors which traders watch when trying to determine the long term fundamental position of the dollar, which are:

1. Its status as the reserve currency of the world,

2. Countries willingness to use the US Dollar in their currency pegs, and the soundness of those pegs

3. Foreign interest in the US Dollar, and US Dollar denominated assets, from individuals and corporations,

4. The pricing in dollars of commodities in international markets

That wraps up this lesson and our series on the factors which will determine whether or not the US Dollar remains the king of the currency world. In our next lesson we will look at some of the key fundamental data which tends to move the dollar outside of these four factors, so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading!

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