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2009: A Roller-Coaster Year For The Dollar

In 2009, the U.S. dollar didn't know which way was up.
In 2009, the U.S. dollar didn't know which way was up.
The onset of the global financial crisis in late 2008 initially benefited the dollar, as investors fled riskier markets for the relative safety of the U.S. currency.

By February, the dollar had made huge gains against the euro, which fell as low as $1.25.

That came as the U.S. central bank, the Federal Reserve, took emergency measures to tackle the crisis and fight the economic downturn.

Those included slashing interest rates to a record low and launching a program to effectively print hundreds of billions of dollars by buying government debt, a step known as quantitative easing.

As economies showed the first signs of recovery, however, investors reverted to shunning the dollar in favor of investments that promised higher returns.

Soon, that became the dominant theme of the year, says Neil Mackinnon, global strategist at the investment company VTB Capital in London.

"This year, particularly since the Federal Reserve adopted 'quantitative easing' as a formal policy and cut interest rates to virtually zero, the U.S. dollar effectively became for investors and traders a funding currency," he says.

"So investors and traders would borrow in dollars and use those funds to invest in higher-yielding investments like equity markets, like commodities, emerging markets, high- yielding currencies."

By October, the dollar had slumped to its lowest level in over a year, with the euro at more than $1.50.

But the dollar's fall this year has not been as dramatic as some had feared.

"The momentum of that move during the summer seemed to be very rapid, so there were concerns that the dollar could be pushed much lower much more quickly," says Vanessa Rossi, an economic analyst at the London-based Chatham House think tank. "Now we can see that this hasn't actually happened. What we have seen in the last six months has been the dollar simply going back to where it was before the crisis started."

Dollar Rebound

In recent weeks there's even been a bit of a reversal in fortunes for the dollar.

The greenback strengthened during December, with the euro dropping to around $1.43.

Traders say one reason is the flurry of bad news from various parts of the eurozone.

There have been massive debt problems in Greece. Austria nationalized one of its banks, suggesting Europe's banking crisis is still far from over. And other eurozone countries -- Ireland, Spain, and Portugal -- are struggling with high deficits.

A report by Standard Bank Plc this month described the economic situation in Greece and Ireland as "intolerable."

The latest news from the United States, by contrast, is encouraging.

There's growing confidence that the U.S. economy is recovering from its worst recession since World War II.

It officially returned to growth (2.8 percent) between July and September, after four quarters of decline, and other figures have been positive.

That's led to growing expectations that the Federal Reserve might soon make a move that would likely boost the dollar.

"The market is reacting to the most recent jobs data and retail sales numbers and saying, 'Well actually the U.S. economy might be moving on to a firmer footing, which in turn might compel the Federal Reserve to think about unwinding all the various credit easing measures that have been in place this year and even contemplate an eventual hike in interest rates," Mackinnon explains.

Not Out Of The Woods

That's not to say there are no risks for the dollar.

Chief among them, the question of how the Federal Reserve will wind down its emergency measures, and the soaring budget U.S. deficit.

Combined with the cost of ongoing wars in Iraq and Afghanistan, bank bailouts, and a massive stimulus package, the deficit reached a record $1.4 trillion for the 2009 fiscal year ending in September.

And though the huge U.S. trade deficit has narrowed recently, that is still another risk factor for the currency, says John Williamson, an analyst at the Peterson Institute for International Economics in Washington.

"I think it would be pretty rash to say that there is no danger of a dollar collapse," he says. "I don't see it happening in the short run, but if the U.S. deficit reemerged despite the fall of the dollar, then one would get a big reemergence of talk about the weak dollar."

Analysts say there's lingering uncertainty, too, about the dollar's future as the world's dominant reserve currency -- that is, foreign currency held by governments or central banks to pay foreign debt or influence exchange rates.

Foreign central banks are worried about the safety of their dollar-denominated reserves, particularly in Russia and China, which has the world's largest dollar reserves, estimated at $2 trillion.

These two countries have led calls to move away from the dollar to a basket of less volatile currencies.

But many analysts say that fears of dollar diversification are overblown and that countries that hold vast dollar reserves will hesitate before doing anything that would weaken the value of the U.S. currency.

So where does that leave the dollar? Should people hold on to their greenbacks or get rid of them? Will the dollar tumble again next year?

There's no magic answer to these questions.

"At the moment, there is no immediate signal to send the dollar either much weaker or much stronger," says Chatham House's Rossi. "This is why it's hovering with a lot of small-scale volatility. It will take maybe another six months or so before we really see whether there is a sustainable recovery coming through."

2009 In Review

Year In Review

RFE/RL looks back at the stories that shaped 2009. More