If economy is healing, why is the dollar falling?

updated 6:13 p.m. ET May 27, 2009

NEW YORK - The U.S. dollar spiked when the economic crisis was peaking, and it's falling now that a recovery's in sight. What gives?

The relationship between the country's economy and its currency, it turns out, is more complicated now than ever as the government assumes a larger role in propping up the financial system and encouraging economic growth.

Here are some questions and answers about why the dollar has weakened, how much farther it could fall, and what it means for the average American.

Q: How much has the U.S. dollar dropped?

A: It's moved differently versus different currencies. But the U.S. Dollar Index, which measures the dollar against a bunch of other major currencies, is down about 10 percent from early March — when the stock market hit a 12-year low.

The currencies the U.S. dollar has fallen against include the euro, the Australian dollar, the Canadian dollar, the British pound and the Mexican peso. That means visiting Australia, Canada, Mexico and most of Europe will be a bit more expensive now for American travelers than earlier this year.

The U.S. dollar index is still up, though, from a year ago.

Q: Why is the dollar retreating?

A: It's partly because the U.S. economy is weak. Usually, a currency is regarded as a barometer of a country's economic conditions, or standard of living. But even more so, the dollar is falling due to the nation's growing debt.

The dollar actually gained in value versus rival currencies when jitters about the U.S. economy were peaking in the six months leading up to March. That's because investors were even more worried about other countries' economies, which tend to lag the United States.

But as the months wore on and the Treasury Department continued to issue record amounts of government bonds into the market to finance its stimulus and bailout packages, the dollar has become less and less attractive to investors. The U.S. budget is expected to hit a record high of $1.84 trillion this year.

A poor economy and high debt weaken a country's currency because investors decide that they're better off buying bonds, stocks and other assets in countries with stronger economies and more stable debt. Stronger countries' assets — and, thus, the currencies those countries use to value their assets — are more likely to rise in value, and their debt is less likely to default.

The dollar took an especially hard hit last week, after Standard & Poor's said Great Britain's swelling debt might force the credit agency to lower that country's credit rating. The agency's warning raised worries among investors that the United States might see its own credit rating lowered.

Q: What would if mean for the U.S. economy if the country lost its triple-A rating?

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