People want some kind of return on their money.  Especially with the threat of inflation, no one wants to keep their money sitting in their plain-jane bank account.  Where have people been putting their money lately?  It used to be in emerging market mutual funds, financial short ETFs, bull and bear market ETFs, hedge funds and private equity funds.  Many of these saw massive selloffs in September (2008).

It used to be in gold, but gold has also seen a massive selloff and drop in prices (largely because much of it was held by the hedge funds).

It used to be in oil, but with much lower predicted global demand, oil has fallen through a couple of its floors, amazingly 50% and more lower than when it was at its highest at the beginning of last summer - remember all that “pain at the pump?”!

It used to be in money markets, until the famous case of the US money market fund that “broke the buck;” that is, unit prices dropped below a dollar, effectively bankrupting the fund.

So where is the money going now? The next two safest vehicles: US Treasuries (ie., the government’s debt) and cash (ie., greenbacks).

As people sell off their fund holdings and switch over to cash, demand for greenbacks increases, making the supply effectively come down.  This causes the nominal value of the dollar to rise.

Likewise, when everyone domestically is buying up US debt instruments, this also helps fund the Fed, which is always good for the dollar (it’s the same process with nations like China and Japan holding US Treasuries in order to help keep the dollar in the range that they like it).

What does this all mean?  It means that the two main factors propping up the dollar right now are temporary and very circumstantial. True, foreign countries will continue to hold dollars in their reserves, but the cause of the recent climb in the greenback is due to the domestic economic crisis (ironically enough).  As soon as the markets anywhere start improving, or as soon as the bailouts start kicking in, I think we can’t but see the decline in the greenback return.  And I didn’t even mention all that printing yet…