Saturday, May 05, 2007

Rethinking the US Dollar Index

5 May 2007

John Doody (the Gold Stock Analyst) has recently taken apart the US Dollar Index (USDX) and put it back together again.

The present USDX is not trade-weighted, and has become increasingly out of proportion to the reality of US trade over the past 24 years. It overweights the Euro Zone by a factor of three (at 57.6%), underweights Canada by almost 50% (at 9.1%), and omits China (0%) entirely.

Mr. Doody has re-calculated the index based on weights available at the Federal Reserve Board website as follows (adjusting the following figures proportionately to make 100%):

Euro area 17.6
Canada 17.5
China 15.1
Mexico 9.6
Japan 9.5
UK 4.5
Korea 3.7
Taiwan 2.5

The two indices were roughly equivalent in 1983, but have since diverged considerably.

Mr. Doody’s recalcualted index peaked in 1985 and 2002 at 139.86, and has presently fallen to 110.85.

This is in contrast to the USDX, which peaked in 1985 at 164.72, but only modestly at 120.9 in 2002, and which is now in the .80 range.

That is, the USDX has lost half its value since 1985, but the trade-weighted dollar index (based on 2006 trade weightings) has lost only 21% of its value since 1985.

Doody is in the camp of the gold bulls, but he is cautioning us to be objective in our evaluation of the declining US dollar. I think he has a valid and important point.

For more information, visit Mr. Doody's website to subscribe to his monthly newsletter.

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