Federal Reserve / Foreign Exchange Value of the Dollar
June 24, 2010    Disclosures    POSTED IN  EconomyInternational

Each year the Federal Reserve calculates the foreign exchange value of the dollar. While the publication describing the methodology gets a bit technical the main objective of the index is to “summarize the effects of dollar appreciation and depreciation against foreign currencies on the competitiveness of U.S. products relative to goods produced by the major trading partners of the United States”.

In the paper the index is described  as intending to, “primarily measure the competitiveness of U.S. goods in international trade. These economies can be important either because the United States imports substantial amounts of goods from them or because the United States exports products that compete with goods produced in those economies. Exchange rates influence competitiveness because they affect the relative prices of goods as perceived by sellers and buyers. The weights associated with each of the currencies are designed to reflect the importance of the respective economies for trade competition.” (Emphasis added)

From the early 1970s to the late 1980s the foreign exchange value of the dollar was impacted in a fairly static manor. Trade competition with other countries was relatively stable on a comparative basis. During the early 1990s two events changed the foreign exchange value of the dollar dramatically, China’s economic rise (coupled with a Yuan peg to the U.S. dollar) and the NAFTA agreement of 1994. As the chart below illustrates, China has increasingly impacted the foreign exchange value of the U.S. dollar. Over the same period the impact of Japan on the foreign exchange value of the U.S. dollar decreased. Starting in 1994, when NAFTA went into effect, Mexico’s impact on the foreign exchange value of the U.S. dollar has increased while Canada’s impact has drifted slowly lower.

Total Trade Weights as of May 17, 2010

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