The dollar index and “firm” exchange rates

No global exchange-rate system lasts forever. Whether a pure gold standard, a single-currency dominated standard such as that enjoyed by the British pound during the 19th century and the U.S. dollar during the Bretton Woods system of fixed exchange rates after World War II, every system ultimately falls under the weight of its internal stresses and rigidities. A set of events eventually comes along that causes the system to collapse.

This was true for the Bretton Woods system, the dollar gold system created in 1944 which lasted until the early 70s, and is going on right now with the current system of floating exchange rates. Future economic historians are likely to regard the past 30 years as a well-intentioned but ultimately failed experiment. The abandonment of this regime will have significant implications for global yield curves, long term interest rate levels, and returns on assets.

Central banks are seldom ahead of the curve; they react to events. Their behavior — and that of associated governments during the transition from the Bretton Woods regime — is instructive in this regard. It will help guide us into the emerging world of two major currencies — the dollar and the Euro. We will also see why the New York Board of Trade (NYBOT) dollar index (DXY) is and will remain the best instrument for tracking and managing the U.S. dollar’s course in the years ahead.