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Friday, May 6th, 2011
a new dollar

When someone talks about “the dollar,” what they mean depends upon the construct that they use to define it.  The most common is the U.S. Dollar Index (DXY), but a new index is on the scene, the Dow Jones FXCM Dollar Index.  As you can see from the chart, you’re going to get about the same exposure either way, but there are times when the two deviate from one another.

So, as with all indexes, it pays to do a little work to see what’s under the hood.  Despite its widespread use, I’d wager that not too many folks know much about the DXY.  (I didn’t.)  It’s in the hands of IntercontentalExchange (ICE) and the value of the index is derived from its value versus six currencies.  In looking at the product information you can see that this measure is dominated by the Euro, which comprises over half of it.  For comparison, the currency percentage for the Euro in the trade-weighted dollar, as computed by the Federal Reserve, is short of 18%.  Nevertheless, the DXY brochure illustrates the high correlation between the two (although the information is a couple of years out of date).

The Dow Jones FXCM measure suffers from a similar issue.  It equal weights “four of the world’s most liquid currencies:  the euro, British pound, Aussie dollar, and Japanese yen,” as seen in the product literature.  The focus of the index seems to be the most popular trading vehicles, no surprise given that FXCM (newly public with its name as its ticker) is in the business of facilitating foreign exchange trading (just as ICE is).

Which is all fine, as long as you know what you’re trading.  A day will come along when the traders of one “dollar” will do much differently than the traders of another.  The macro implications of that will depend in part upon the layers of structure and leverage built upon the indexes over time and, of course, the total amount of money on the line, which by every indication has increased rapidly of late.

And given China’s growing importance economically, something eventually will have to give in each of these dollars, new and old.  (Chart:  Bloomberg terminal.)