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Anthony Mirhaydari

Extra11/25/2009 4:00 PM ET

The dollar's down decade

The greenback's decline has cut deeply into Americans' buying power over the past 10 years, raising fears of a complete collapse. But here's why it could turn around.

By Anthony Mirhaydari
MSN Money

Americans normally have little reason to worry about foreign exchange -- "forex" in the lingo of the trading world. We are paid in dollars. We buy groceries in dollars. The undulations of the yen, the euro or the Swiss franc are easily ignored.

Besides, the world's monetary system is an impenetrable and abstract concept. Even professional investors and academics have a hard time explaining what drives currency movements: It's a mélange of savings, spending, interest rates, inflation, money supply, economic growth, government policies and trade balances, among other factors.

But you don't need to be an expert to notice the 38% drop in the dollar since it reached a high in summer 2001. Or to worry about it, given the 15% drop since March.

US Dollar Index © StockCharts.com

You've no doubt also noticed the effects of the dollar's lost decade. Crude oil has gone from $17.45 a barrel to trade near $80 today, a rise of 358%. Gold has gone from $255 an ounce to more than $1,140, a gain of 347%. Commodities in general, as represented by the Jefferies CRB Index, have gained 51%. And according to The Economist, the cost of a Big Mac has gone from $2.54 in 2001 to $3.57 now -- an increase of 41%.

Clearly, in global terms, the purchasing power of U.S. consumers has declined dramatically.

Now consider the effect on investments. The Dow Jones Industrial Average ($INDU) sits about 10% below the level of New Year's Day 2000. But after accounting for the dollar's decline, the real return is minus-33.9%.

That has raised questions and, lately, a lot of fear. Is the dollar's decline intentional? Is it good or bad? And how far might it fall in the next decade?

On the last question, I have a positive prediction: The end of the dollar's decline could happen next year as investors again trade risk for safety.

But first, to really explain where the dollar stands, we need to look at the history.

Off the gold standard

The average American was taken off the gold standard in 1933. President Franklin Roosevelt, by executive order, declared personal ownership of gold coins and gold-backed dollars illegal. (It was made legal again during the Ford administration.)

But the gold standard ended for the rest of the world in 1971, when President Richard Nixon canceled the ability of foreign governments and central banks to convert dollars to gold.

Nixon's action ended what was known as the Bretton Woods system, formed in the aftermath of World War II, that pegged the dollar to gold at $35 an ounce and fixed major exchange rates to the dollar.

Video: Is the dollar at a breaking point?

Since then, the world has operated on fiat currency -- basically, money is worth something because a government says so, but has no fixed value -- and exchange rates have been mainly set by the market.

The exceptions have been those nations that have manipulated exchange rates to pursue export-oriented growth policies. In earlier years, the main manipulators were Germany and Japan. Today it is China.

Continued: The 'exorbitant privilege'

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