by Jeremy Rutherfurd

Created on: November 11, 2007   Last Updated: February 25, 2008

There has been much hand wringing of late over the plummeting value of the US dollar. Since 2003 the currency has fallen 28 percent against the Euro, 10 percent against the Japanese yen, 12 percent against the Chinese yuan and 16 percent against the Indian rupee. Almost every day the U.S. dollar tests new lows and there seems to be no end in sight to its depreciation.

Many people attach special significance to the value of their national currency. When it goes up in value they feel their country is strong. When it falls they worry they're somehow slipping as a people. So while the British may be feeling good nowadays - their pound has risen 23 percent versus the US dollar over the last five years - Americans are not especially happy, and some are feeling downright poor (especially US students traveling abroad).

"How can we shore up the value of our national currency?" Americans ask.

Unfortunately, there is little that can be done in the short run to boost the value of the dollar. The currency is weak because US interest rates are relatively low, the economy is slowing (due mostly to the subprime mortgage crisis) and Iraq remains a problem.

It is commonly believed that the ongoing conflict in Iraq is the main factor depressing the US dollar, but that's simply not the case. The value of a currency is determined by whether investors buy up that currency (by purchasing US Treasury Bills or stocks, for example), and they will do so if they think they will get a worthwhile return, regardless of most other factors. Therefore, if US interest rates were relatively high and the prospects of the US economy were good, investors would be lining up to buy US T Bills and shares no matter what America was doing overseas. The fact is, however, that interest rates have been falling, they will most likely continue to fall, and the short-term outlook for the US economy is not good.

The US Federal Reserve, which is basically America's central bank, has lowered the Federal Funds Rate twice this year. (This is the interest rate on overnight loans between banks, and is the standard by which many other interest rates - for example, those on credit cards - are set.) At the same time, the European Central Bank has kept its interest rates unchanged. Furthermore, there is every indication that the Fed will continue to cut rates, while the ECB will not, and may even raise rates. The reason for this is that the ECB is trying to stave off inflation, while the Fed is trying to prevent a recession.

The

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