us dollar index

By all accounts, the U.S. dollar should be the functional equivalent of a Zimbabwean bill.

The Fed has pumped trillions into the worldwide financial system as part of misguided stimulus efforts that should be incredibly inflationary.

Yet, instead of a disastrous repeat of the Weimar Republic, the U.S. dollar has strengthened considerably.

This despite rising unemployment, slowing economic growth and a debt debate that's about to begin anew.

Since last July, the U.S. dollar has risen against all 16 major currencies while the Intercontinental Exchange Dollar Index is up 12%, according to Bloomberg.

In fact, the greenback is now higher than it was when the Fed engaged in Operation Twist in late 2011 as part of a plan to keep the dollar low by buying bonds.

So much for Club Fed's plans...

As usual, they don't really have a clue about how real money works -- let alone why it flows and where it's going.

Taking the Mystery Out of the U.S. Dollar

Here are the three reasons why the U.S. dollar is really rising:

1. Institutions are unloading gold to raise cash against anticipated margin calls, redemption requests, or both. They are parking that money in treasuries and in dollars, creating additional demand. There are simply more buyers than sellers at the moment, so prices for dollars and treasuries are rising. And not just by small amounts, either.

2. Institutional portfolio managers and traders are required to maintain specific classes of assets under very specific guidelines. These guidelines dictate everything from the amounts being held to the quality of specific investments.

Many, for example, are required to hold only AAA-rated bonds, or invest in stocks meeting certain income, asset size and volatility criteria.

Imagine you're Jamie Dimon and you have to hold reserves against trading losses or you're Mark Zuckerberg and you've got to build up a large legal settlement fund for the Facebook IPO.

Or, perhaps you're Tim Cook of Apple and you're sitting on $110 billion in cash for future investments.

Chances are you're going to want to buy things that are as close to risk-free as possible to ensure your assets hold their value.

A year ago, you could choose from eight currencies in the G10 that met internationally accepted "risk-free" ratings criteria as measured by the cost of credit default swaps priced under 100 basis points.

Now, there are only five to choose from. A year from now, there might only be two or three.