The US Dollar Index: Is What?
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| Topic: Other — August 16th, 2007
A number of readers have asked us to explain the US Dollar Index as various researchers and analysts including ourselves refer to it, so here goes.
In order to monitor and track the performance of the US Dollar on the global stage we compare it to a basket of other currencies. This is similar to any other stock index such as the DOW or the FTSE, whereby a small collection of stocks representing the market are placed into a basket, the movement of which broadly reflects what is going on in the market.
This basket consists of the following currencies:
Euro
British pound
Japanese Yen
Canadian Dollar
Swedish Krona
Swiss Francs
But please note that not all the currencies carry equal weighting as denoted by the pie chart below courtesy of babypips.com and akmos.com.
Pie chart:
Now if we take a quick look at the recent chart for the US Dollar Index we can see that the graph reflects the general performance of the value of the US Dollar on the world stage.
The US Dollar Index:
Many analysts view ‘80’ as a psychological support level so whenever the Dollar gets close to that level a number of ‘alerts’ are flashed by various traders. Whether or not the Dollar will drop dramatically after a significant close under the ‘80’ level remains to be seen. This index has been in use since 1973 and will no doubt be updated periodically, for instance if the Britain were to join the Euro the British pound would be removed from the basket and the Euro would have its weighting increased.
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This explanation doesn’t clarify a thing. Most, if not all of us, already knew the U.S. Dollar Index reflected the dollars value versus the baket value of other currencies.
What we don’t understand is how the index is designed. What does it mean when you say the dollar index at the end of the day is 80? Obviously, we understand the higher the index the stronger the dollar & vice versa….but…how the heck is that calculated? Also, if the index drops to say 70…how does that affect the price of gold? How does it affect inflation…or any other economic indicator?
Comment by Chuck Lewis — August 18, 2007 @ 6:04 am
If it drops to ‘70’ then it has depreciated against the basket of currencies. This means that the US will have to pay more for imported goods but US manufacturers would gain an advantage, as their goods are now cheaper.
With $2 to the British pound many Brits will go on a shopping holiday to the states, as there are bargains to be had.
In the case of gold we a have a measure and we know that $656 buys one once of gold, so we have a direct relationship which we can monitor.
However there are a number of analysts who have referred to the ‘80’ level as the level that the Dollar must hold. Should it fall through that level significantly then they foresee a number of organisations unloading it in order to protect themselves. The knock on effect could be dramatic if the Dollar is universally dumped.
Comment by Gold Prices — August 18, 2007 @ 1:11 pm