The Fundamentals of a Falling Dollar

One of the more confused propositions in the realm of currencies and exchange rates is the belief that the value of a currency is measured or determined by the exchange rate. For example, the dollar has fallen about 13 percent against the euro in this year and has lost about a third of its value against the euro since mid-2001. This makes some people believe that the value of the dollar has fallen and the value of the euro has risen. From observing the exchange rate, people do make inferences about the value of each currency[i].

I respectfully challenge that view. The exchange rate is a measure of the relative value of these two currencies, not the value of the dollar or the euro per se. We cannot a priori rule out either that both the value of dollar and the euro has risen lately but the euro a bit more, or that both has lost in value but the euro less, or that one of them has kept its value and only the other changed. I believe both have lost value since mid-2001, as we shall see below, only the euro has lost less.