Question

In: Finance

What happened the value of the United States dollar during the Great Recession?

What happened the value of the United States dollar during the Great Recession?

Solutions

Expert Solution

Bank of international settlement gave four reasons of dollars rise during great crisis:

1. Safe haven currencies

Safe haven currencies are currency that is more preferred during the time of uncertainty. There are 3 safe haven currencies:

  • US dollar and US treasuries
  • Japanese Yen and japanese government bonds
  • Swiss Franc and swiss government bonds

So, when great recession took place all economists thought that dollar value will depreciate, which in turn will bring back the economy on track. But the value of dollars appreciated because people started investing in US treasury bond ( one of safe haven currencies ).

2. Carry trades

Carry trades means borrowing currencies with low interest rate and investing it in currencies with higher interest rate.

Prior to crisis, US rates were higher than yen rate. Therefore US and japanese investors borrowed yen at low interest rate and exchanged it with dollar to invest in USD dominated assets. When crisis happened , investors sold the us dominated assets for dollars to pay yen loans. The sudden demand for yen pushed it's exchange rate against dollar.

3. Shortage of USD

Before the crisis, European countries had more US dominated assets than US deposit. Conversely US bank had few foreign dominated assets and high US deposit.

During the crisis, European countries needed more dollar to pay the dollar debt, which led to dollar appreciation.

4. Overhedging

Since foreign countries had more USD dominated assets before the great recession. After recession, the assets side of balance sheet of foreign investors shrank as the prices of USD dominated assets fell.

They bought the US dollar to pay USD dominated debt, which the rate of dollars.


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