Four factors that affect the U.S. Dollar.

If you ever wonder about the forces that control when and how much your dollar can buy, then exploring the fiat currency system will help. A "fiat" currency system, the U.S. dollar is not backed by gold; instead consumer consumption supports the dollar.

Supply and Demand:

First of all, the laws of supply and demand manage consumer consumption so that consumers retain power in the system. The Federal reserve acts as chief distributor controlling the money supply which is represented in the form of liquid cash, small time deposits, and jumbo reserved deposits. On the other hand, foreign banks and individual traders control the demand for the U.S. dollar. Annually, banks and individuals ensure that the dollar remains the top reserved currency. On average, the dollar represents 65% of all reserved currency.


Trade Balance:

Likewise, the trade balance plays a role in the fiat currency system. As an import based economy, the U.S. economy depends on imports from trading partners like Canada and Mexico on a day to day basis in spite of the enormous trade deficit. Imports from Canada alone account for over $315 billion annually. However, the United States remains a debtor country.


Economic Reports:

To measure the performance and health of the economy, policymakers conduct monthly reports like the Consumer Confidence Report or use indexes like the Cost-of-Living Index. These reports ensure that the dollar is sustaining its value. Generally speaking, the public gets a chance to voice opinions about the unemployment rate, price of commodities, and housing stats. When things go awry in the economy, policy makers look to economic reports to make corrections.


Politics:

Aside from the other controls, politics place limits on the dollar. Especially during Election Year when the House changes from Democratic to Republican or vice versa, politics determine in which direction the dollar should flow. Checks and balances remain in tact. Even a tragedy like 9/11 can send the dollar through a downward spiral into a recession.

Issues:

Some questions to answer as we go through another decade on the fiat currency system are: how much of the negative trade balance has to be paid before we return to the Gold standard? How will the overall health of the economy change on the Gold Standard? Also, what happens when foreign banks decide to use other reserved currencies?