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Written by Michael Rizzo
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Wednesday, 05 March 2008 02:00 |
The Bretton Woods system collapsed in August, 1971 when the gold window was closed. In 1973 the value of the newly created US Dollar Index was 100. Under the Bretton Woods system, exchange rates were fixed at government determined levels. The US Dollar Index is a measure of the value of the US Dollar relative to a basket of major foreign currencies that circulate widely outside of their country of issue.
The chart below depicts how the value of the US Dollar has fared against the (trade-weighted) average value of currencies from the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden. The weights are assigned to reflect the importance of the respective economies for trade competition.
On Friday, February 29, 2008, the index hit its lowest value, 70.85, since its inception in 1973. Broadly speaking, the dollar has lost 30 percent of its international exchange value since the gold window was closed, and almost 80 percent of its value since reaching a peak of 148.12 in February 1985.
Will the international exchange value of the dollar continue to fall? Economists have an awful record at predicting exchange rate movements. In fact, even forward exchange rate contracts are useless at predicting actual future exchange rate movements. At best we can say that exchange rate movements are likely to be very volatile - and that this instability was not well foreseen by the proponents of the flexible exchange rate system.
Exchange rates can be driven down for several reasons, all of which may be at play in the dollar's recent decline. The major drivers include differences in inflation rates across countries (with higher inflation resulting in a devaluing of a currency) and differences in economic growth rates across countries, but other factors clearly matter as well.
You can read more about this issue in The Future of the Dollar.
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