What Determines the Strength of the Dollar?

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Since most global currencies are allowed to float against each other, which allows their exchange rates to fluctuate, the dollar's strength is determined by supply and demand. Factors such as relative economic strength, political perception and inflation affect the worldwide supply and demand for dollars.

Perception of U.S.

  • Historically, the demand for the dollar has been kept high because the U.S. has been viewed internationally as economically strong and politically stable.

Inflation

  • When more U.S. dollars are printed and their supply increases, the dollar's strength is reduced.

Purchasing Power Parity

  • One way to compare the relative strength of the dollar to other currencies is by using purchasing power parity. This metric compares the amount of actual goods that can be bought with a specified quantity of a currency.

Dollar Index

  • You can track the strength of the U.S. dollar by watching the U.S. Dollar Index, which compares the U.S. dollar with a basket of foreign currencies.

Trade Effects

  • When the dollar is weak, it makes imported goods more expensive for Americans and exported goods less expensive for foreigners to buy.

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