Secondly, Mise, could you try again (or JH, or someone else) to explain why the dollar has increased so greatly in value over the course of the financial crises. I didn't really follow your logic in your previous post.
I'll give it another go
Imagine Bank A lends at a rate of 3% per year, while Bank B pays 6% interest on savings accounts. If you borrowed $1,000 from Bank A and put it into a savings account with Bank B, you would pay $30 a year in interest to Bank A, and receive $60 from Bank B, thereby making a profit of $30 per year. Now, obviously, banks within the same country wouldn't ever do this, because if they pay more on deposits than they receive in interest, they lose money. But bank's interest rates are guided by the country's central bank's base rate, such that the rates they lend at and the rates they pay on deposits hover around the central bank's base rate.
In the US, the Fed dropped rates massively after the dot-com bubble burst earlier this decade. Since then, interest rates in the US have been much lower than interest rates elsewhere. Investors used the logic above to borrow money from US banks at a very low rate and invest the money in countries with higher returns. For example, they might borrow at 3%, and invest in emerging economies such as Brazil, India, China, Russia, and Eastern Europe, where there are many investment opportunities and the prospect of a nice fat return.
So, for example, they go to a bank, and borrow $1,000. In order to invest this in, for example, Brazil, they have to convert the $1,000 into Brazilian Real. Lets say the exchange rate is 3 Brazilian Real per 1 US Dollar. This means that 1 USD will buy 3 BRL. In other words, in order to change $1,000 into BRL, you are in effect paying USD1,000 for BRL3,000. You're buying BRL and selling USD. This means that the US Dollar depreciates (selling means less demand and more supply) and the BRL appreciates (buying means more demand and less supply).
This was the basis of the carry trade - borrow Dollars and Yen, and invest in more lucrative countries. It meant that the Dollar and Yen depreciated relative to most other currencies.
Now, however, investors are worried that emerging economies are going to get hit pretty hard from the global recession, and are pulling their money out. There's also finding it difficult to borrow from US banks, for obvious reasons, and those that have borrowed are worried about banks calling in those loans. So they've started unwinding those positions. This means selling Brazilian Real and buying US Dollars, meaning that Dollars appreciate and Real depreciates.
That's also why the Yen went up too.
What JH is saying about other countries depreciating even further than the Dollar is also true, though. The US Dollar is
still the world currency, despite the HUGE government borrowing (public debt is 80% of GDP now!!). Investors just have faith in the Dollar, much more so than the pound or the Australian dollar. The Euro is regarded as fairly safe too, but the dollar more so.
