The U.S. dollar value has been pressured by macroeconomic developments and Federal Reserve Bank policies.
In today's foreign exchange market, most national currencies operate under a floating exchange rate, where value is allowed to fluctuate freely against other currencies and financial assets. Many macroeconomic factors can cause devaluation of an individual currency, including central bank monetary policies to increase money supply, excessive national debt and weak economic growth prospects. Economies dependent on manufacturing and exports or those running a trade deficit may pursue intentional policies of currency devaluation to boost exports. Rapid devaluation can occur during a currency crisis, as investors lose confidence due to individual events, government policies or fear of sovereign debt default.
Excessive Debt
Under normal circumstances, investors and speculators determine the relative valuations of currencies based on perceptions of key macroeconomic factors. Countries with excessive debt will often experience currency devaluation as speculators perceive greater risk. Excessive debt can lead to interest payments constituting a large portion of a national budget, reducing capacity for productive governmental expenditure and placing a drag on economic growth. A country's credit rating can also be damaged by excessive debt, leading to higher future borrowing costs, an economically damaging development. A country facing a large debt burden also may intentionally devalue its currency to monetize its debt, or reduce the value of the debt in real terms.
Central Bank Activities
Central banks play a vital role in currency valuation. Each central bank controls its own country's monetary policy and also holds a large volume of foreign currency reserves. The world's central banks hold a sizable amount of foreign currency reserves, adjusting their holdings based on perceptions of future trends. With respect to monetary policy, most central banks have two primary mandates --- controlling inflation and enabling steady economic growth. Central banks accomplish their objectives mainly by controlling the amount of monetary liquidity in the economy. By lowering interest rates or reducing required bank reserves, central banks make more money available in the economy. The increase in money supply in turn tends to drive down the value of the currency due to simple supply-and-demand dynamics.
Economic Growth and Central Bank Policies
When evaluating currency purchases, speculators assess a country's growth prospects. If future economic growth appears to be weakening or entering recession, speculators likely will presume that the country's central bank will move to increase liquidity to stimulate growth. Lower interest rates result in reduced borrowing costs and increased economic activity. Therefore, economic slowing leads to looser monetary policy, which leads to currency devaluation.
Currency Crisis
A currency crisis occurs when speculators rapidly lose confidence in a country's economy or monetary policies, often due to emerging potential for default on national debt. During a crisis, considerable selling momentum can develop as holders of the currency in crisis race to sell their positions. Recent examples include the Latin American crisis of 1994, the Asian crisis of 1997 and the crisis in Zimbabwe after 2000.
Special Case of the U.S. Dollar as Reserve Currency
The U.S. dollar faces special circumstances as it is regarded as the reserve currency for the world, meaning it represents a particularly large portion of foreign currency reserves in most countries. The dollar is also the default currency for trading oil. Because of its status, the dollar trades at a premium, as of 2011. A likely future transition away from the dollar as either reserve currency or default oil trading currency would lead to significant dollar devaluation over the long-term future.
