So if interest rates in US go down, does that weaken the dollar? And if Japan, or anyone sells dollars, that can weaken it too? What else can make that happen?
It is true that the dollar has gone down like 12% recently, right?
I will get this.
You live in a world of commodities. Think of everything as an asset or a liability (or both). A perfectly nice dress, wrapped and carefully preserved, might be unwearable from a fashion point two years later. Fifty years later, still perfectly preserved and unworn, it might command a huge price premium as a "classic."
Valuation is in the mind. What gives assets their value--including paper assets--in a market is the demand for them. The dollar's value will fluctuate not just in terms of its exchangeability vis a vis currencies but vis a vis goods, depending on the prefernce the dollar holder has for "being long" in dollars or "being long" in something else, such as cars, bonds, or whatever. The dollar can "gain" relative to the yen not as a reflection of anything happening on the American side but as a reflection of depreciate esteem for holding yen. And vice versa. These movements can be greatly exaggerated through the taking of speculative positions.
So we can say, *traditionally* a lower US discount&/or fed funds rate leads to lower yields across the full spectrum of bonds and *traditionally* this tends to decrease the value of being "long" in dollars. So the dollar is esteemed less and its value falls.
But the emphasis is *traditionally*. The official dollar price recorded at the end of the day is the price of the last transaction, which reflects the estimation of value, not of all holders of dollars, but of the parties of the last transaction. As with stocks, the last transaction sets the "price" until the next transaction. But we can't say what factors will affect the next party to step up and bid for dollars relative to some other currency. That transaction might be speculative or driven by a need to meet a contractual obligation for a "real" purchase of some dollar good.
So you question may be rephrased: what is it that affects the price set for the paper asset known as the dollar. And the answer is: at any given time, many different things, not all of which are knowable.
-- Gregory P. Nowell Associate Professor Department of Political Science, Milne 100 State University of New York 135 Western Ave. Albany, New York 12222