What Is Trade-Weighted Dollar?
The trade-weighted dollar is an index created by the Federal Reserve (Fed) to measure the value of the U.S. dollar (USD), based on its competitiveness versus trading partners.
- The trade-weighted dollar is an index created by the Fed to measure the value of the USD, based on its competitiveness versus trading partners.
- The index gives importance to currencies most widely used in international trade, rather than comparing the value of the U.S. dollar to all foreign currencies.
- The trade-weighted dollar is used to determine the U.S. dollar purchasing value, and to summarize the effects of dollar appreciation and depreciation against foreign currencies.
Understanding Trade-Weighted Dollar
The trade-weighted dollar is used to determine the U.S. dollar purchasing value, as well as to summarize the effects of dollar appreciation and depreciation against foreign currencies. When the value of the dollar increases, imports to the U.S. become less expensive, while exports to other countries become more expensive.
The trade-weighted dollar is a measurement of the foreign exchange value of the U.S. dollar compared against certain foreign currencies. It gives importance, or weight, to currencies most widely used in international trade, rather than comparing the value of the U.S. dollar to all foreign currencies. Since the currencies are weighted differently, changes in each currency will have a unique effect on the trade-weighted dollar and corresponding indexes.
The Trade Weighted Dollar Index, sometimes called the Broad Index, was introduced in 1998 in response to the implementation of the euro (which replaced many of the foreign currencies that were previously used in an earlier version of this index) and to more accurately reflect current U.S. trade patterns.
The Fed selected 26 currencies to use in the index, anticipating the adoption of the euro by eleven countries of the European Union (EU). In 2019, the Fed said the 26 represented economies accounted for about 90% of total bilateral trade with the U.S.
Trade-Weighted Dollar Index vs. the U.S. Dollar Index
The other primary index used to measure the strength of the USD is the U.S. Dollar Index (USDX). Created in 1973, it is composed of a basket of six currencies—the euro (EUR), Japanese yen (JPY), British pound (GBP), Canadian dollar (CAD), Swedish krona (SEK), and Swiss franc (CHF).
The EUR is, by far, the largest component of the index, making up almost 58% (officially 57.6%) of the basket. The weights of the rest of the currencies in the index are—JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%), CHF (3.6%).
When the Fed introduced the Trade Weighted Dollar Index, it hoped to create a better alternative to the USDX, namely by using more currencies and periodically reviewing the index's composition. The Trade Weighted Dollar Index includes countries from all over the world and its weighting is updated once a year based on annual trade data published by the Bureau of Economic Analysis (BEA).