Given that the United States economy is far and away the largest single economy in the world (close to three times the size of second place China), it is not surprising that the U.S. dollar holds the position that it does. The United States dollar is by far the most significant currency in the global market; it is the dominant reserve currency of the world, it represents nearly half of the trading volume of the major currencies, and it is the default currency for most transactions.
There are numerous models and theories that attempt to predict currency exchange rates on the basis of relative interest rates, price levels, and so on. These models do not work especially well in practice, though, as traders consider numerous factors in their buy/sell decisions and the momentum of speculation itself can influence exchange rates. In other words, currency is like another "product" with extensive supply and price is determined by changes in demand.
The strength and weakness of currencies are generally assumed to follow trends in supply and demand, and the United States dollar should be no different. Since at least the middle of the 20th century, however, the dollar has held a special status around the globe as a reserve currency. This means that individuals, companies, and governments have carried out international trade and held their capital reserves in dollar-linked accounts.
Over time, that role was reinforced by the widespread perception that the U.S., backed by a stable institutional and political environment, is an economy that provides ample liquidity and a safe haven for investment from around the globe. This has given rise to an abundance of dollar trade outside the borders of U.S. territory known as the “eurodollar” market, which has amplified the global implications of U.S. policy moves and economic indicators. As a reserve currency, the dollar historically has benefitted from particular stability in relation to many of its counterparts. However, even the dollar suffers from bouts of volatility.
Additionally, monetary policy can affect the long-term prospects for activity and growth in the economy that influences revenues, earnings, and dividends. As such, it is common for investors and the dollar rate to react, often in real time, to news and announcements related to interest rates and interest rate policy. These include events such as statements by Federal Reserve officials and the minutes of the Federal Open Market Committee (FOMC), where hints about future interest rate policy are thought to be revealed.
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