The Washington Post recently reported that with the prospect of the Fed maintaining lower interest rates than its counterparts elsewhere, the US dollar is losing its status as the world’s safe currency in troubled times. The dollar is still dominant but when the European economy gets its fiscal issues resolved – could take a long time – that might lead to a shift away from the dollar to the euro. However on a positive side for the decline in the US$ is that it has been more systematic and not driven by foreign exchange speculators getting out of dollars but by sentiment that the euro, the GB pound, the Canadian dollar are a better buy at this stage. This is ironic as the US economy is starting to pick-up pace, albeit slowly, and the debt crisis in Europe seems to be getting worse – Portugal look as if they will need to be bailed out.
Remember that high interest rates attract foreign investment into a country which means that investors have to change their currency, in the foreign exchange market, into the currency of that country that they wish to invest in. Therefore the demand for that currency goes up which means that it will increase in value. Ben Bernanke has consistently said that he wants to keep short-term interest rates near to zero for an extended period – whatever that means.