Monetary policy, trade policy, and geopolitical situation are three essential factors of foreign nations that influence the value of the USD.
In today’s globalized economy, foreign influences play a massive role in determining the value of the United States Dollar (USD). The USD is recognized as the global reserve currency and is used by almost every nation in transactions and investments. Banks and governments also hold it as a part of their foreign reserves. Due to the use of the USD by numerous nations, the strength of the USD can see fluctuations based on the happenings in one or more of these countries. These ‘happenings’ can be broken down into three main factors: other nations’ monetary policies, trade policies, and geopolitics.
Monetary policy decisions of other nations play a massive role in determining the value of the USD. Higher interest rates set by central banks of other countries lead to the relative appreciation of the currency of said country and the relative depreciation of the USD. This is because the currency of said country is now more attractive to American investors due to greater returns on investments (higher interest rates = higher returns). On the other hand, if the US was to increase its interest rates, foreign investors would put money in US bonds (again, higher interest rates = higher returns), and to do this they would need more US dollars, and there would be an increase in the demand for US dollars. This increase in demand would in turn appreciate the value of the USD in comparison to foreign currencies.
(People’s Bank of China)
International trade is another factor that drastically impacts the value of the USD. If the US imports more than it exports, it would need more foreign currency (to buy these imports), thus the value of the USD depreciates relative to foreign currencies. On the other hand, if the US exports more than it imports, the demand for the USD increase (because you need US dollars to buy US goods), and thus foreign currencies depreciate relative to the USD. To summarize, trade deficits (imports > exports) depreciate the value of the USD internationally, while trade surpluses (exports > imports) do the opposite. In America’s case, the four-decade trade deficit has resulted in a massive decrease in the value of the USD, and this has led to increased rates of inflation in the country. In fact, the current account deficit of the United States increased by 33.4% in 2021. To combat this increased deficit, the US takes out foreign loans.
The final foreign factor that can influence the dollar is the geopolitical occurrences of other nations. Geopolitical events can be a huge factor in determining the value of the USD. If a foreign nation is seen as politically unstable, then people would not see it as a safe place to keep their money, thus appreciating the value of the US dollar. Furthermore, if a war breaks out internationally, then the United States may be seen as a “safe haven” for people to keep their money, and this additional influx of capital would cause the US dollar to appreciate in value. An example of such a situation can be seen from July 2021 to June 2022 when due to the Russian invasion of Ukraine, the value of the USD went up. The USD appreciated 16% relative to the Yen, 12% relative to the Euro, and 9% relative to the Pound. On top of this, disputes with China in the “Trade War” have caused fluctuations in the value of the USD, as the nations have gone through phases of increased protectionism and resumed trade.
The United States Dollar, being the most widespread international currency, is greatly influenced by foreign factors. These factors include the monetary policy, geopolitical situation, and trade policies of other nations. These three factors can change drastically over time, and it is in the best interest of the United States to make sure these factors help, and not hurt, the US dollar.
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