It's been a wild year for the greenback. While the falling U.S. dollar of last week can be blamed on the U.S. Federal Reserve's surprise decision not to taper its bond buying, for most of the past two years, the dollar has been rising.
In fact, before the FOMC meeting last week, the dollar was up 12% since mid-2011.
And yet while the factors contributing to a rising U.S. dollar are likely to continue for a while, investors also need to be aware of several long-term threats to the dollar that eventually will fatally weaken the currency.
It's important for investors to understand exactly why the dollar is falling at times and rising at others, because the strength of the currency affects virtually every investment in one way or another.
Here's a piece-by-piece look at what's been going on this year with the dollar, and what investors can do to profit from it.
The Falling U.S. Dollar: A Reaction to the Fed
Most experts (with this very notable exception) had assumed the Fed would announce a start to the quantitative easing (QE) taper, a reduction of about $10 billion from its $85 billion a month of bond buying.
That would have been helped strengthen the dollar by reducing some of the liquidity that the Fed has been pumping into the U.S. economy. When the Fed instead stood pat, the currency markets reacted negatively. The dollar index fell 1%, to 80.060, a seven-month low, the day of the Fed announcement.
That excess Fed liquidity – the central bank has added $3 trillion to its balance sheet since the 2008 financial crisis – is actually one of the long-term threats to the U.S. dollar, as we'll see shortly.
The falling U.S. dollar reaction to last week's Fed decision, however, will be short-lived.
Before long, we'll return to a rising U.S. dollar, at least for a while.
Here's why it's inevitable that the dollar will soon resume its upward trajectory…