Q: Why is it that the US dollar goes up in times of financial uncertainty? Given the debt mountain they have there, wouldn’t it be more logical for the greenback to lose ground?

A: Understanding currency movements is challenging and often puzzling. Often best understood after the fact! Previously, gold was held as a store of wealth and as tradable currency in the event of global disaster or catastrophe. Since the removal of the gold standard the US dollar has replaced gold as a store of wealth and a proxy global currency.

 

The US dollar is the most actively traded currency in the world. Accordingly it is deemed to be the most liquid form of currency and hence held by nations as a mechanism to facilitate global trade and a store of wealth in uncertain times.

 

While the US national debt has grown dramatically, the US economy is still the largest economy in the world. In addition, the vast majority of global trade is conducted in US dollars.

 

When other countries’ economies are strong or their goods and services are in demand, their currency will appreciate in value to reflect the demand for their goods and services and hence their currency. So, when countries’ demand for Australian goods is strong, the Australian dollar goes up. If economic conditions weaken and demand falls, then the currency will fall.

 

In times of uncertainty, people will seek to hold the currency that is the most liquid to trade. Hence, in these turbulent times, people are moving back to the US dollar. It is appreciating not as a consequence of the strength of the US economy, but perhaps more as response to concerns about the global economy and a reflection of the fact that most trade is conducted in US dollars.

 

This article was published in The Australian on 8 October 2011. A direct link to the article can be found here.
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