Between February 2002 and April 2008, the US Dollar Index fell from 120 to 71 — a 40% decline that took the currency to the lowest level in its history. The causes were compounding: twin wars financed by deficit spending, Greenspan's 1% interest rates that inflated a housing bubble, a resurgent euro, and a world that was beginning to ask whether the dollar deserved to be the world's reserve currency.
The dollar's decline began quietly. In the spring of 2002, the index was still above 115 — within striking distance of its July 2001 peak. The dot-com recession was ending, the Fed was cutting rates to stimulate recovery, and the strong dollar policy was still nominally in effect. Treasury Secretary Paul O'Neill continued to recite Rubin's mantra: "A strong dollar is in America's interest."
But the market had stopped believing. The conditions that had powered the Rubin rally — fiscal surpluses, productivity growth, higher yields than Europe — had reversed. The federal surplus had become a deficit. Productivity growth was decelerating. And the Fed Funds rate, at 1.75% and falling, was approaching levels that made dollar assets unattractive to yield-seeking global capital.
What followed was the longest sustained dollar decline since floating exchange rates began in 1973. Over six years, the dollar fell from 120 to 71 — losing 40% of its purchasing power against a basket of major currencies. The euro, which had launched at $1.17 in January 1999 and weakened to $0.83 by October 2000, surged to $1.60 by July 2008. Commodities, priced in dollars, exploded: oil went from $25 to $145, gold from $300 to $1,000. The world was repricing everything denominated in the depreciating American currency.
Phase 1: The war premium (2002–2003). The buildup to the Iraq War, which began in earnest in late 2002, was deeply negative for the dollar. Unlike the 1991 Gulf War — a brief, multilateral operation with broad international support — the 2003 invasion was unilateral, controversial, and expensive. Markets priced in the cost: hundreds of billions in deficit spending, geopolitical isolation from European allies, and the diversion of American economic resources from productive investment to military operations. The dollar fell from 119 to 90 — a 25% decline — between February 2002 and December 2003.
Phase 2: The Greenspan put (2003–2004). Greenspan held the Fed Funds rate at 1% — the lowest since 1958 — from June 2003 through June 2004. The stated purpose was to prevent deflation. The actual effect was to inflate a housing bubble of historic proportions. Cheap money flooded the mortgage market. Subprime lending exploded. And the dollar, offering 1% yields in a world where the European Central Bank was paying 2% and the Bank of England 4%, had no support from interest rate differentials. The dollar stabilized around 87-89, but the damage was done — the yield premium that had powered the Rubin rally had vanished entirely.
Phase 3: The acceleration (2006–2008). The Fed began raising rates in June 2004, reaching 5.25% by June 2006. Normally, higher rates would strengthen the dollar. But the housing bubble had created a new problem: America was financing $800 billion in annual current account deficits with mortgage-backed securities that foreign investors were buying as "safe" assets. When the subprime crisis revealed these securities to be toxic, foreign capital didn't just stop flowing — it reversed. The dollar crashed from 85 to 71 between mid-2006 and April 2008, hitting its all-time DXY low of 71.54 on April 21, 2008.
The biggest winner of the dollar's decline was the euro. Launched in January 1999 as a currency without a country — or rather, with twelve countries and no unified fiscal policy — the euro had been dismissed as a political vanity project. It weakened from $1.17 to $0.83 in its first two years, prompting the ECB to mount embarrassing interventions. Skeptics predicted it would fail.
They were wrong, at least for a decade. The euro's strength against the dollar between 2002 and 2008 was driven by the same forces that weakened the dollar — European interest rates were often higher, European fiscal deficits were smaller (thanks to the Maastricht Treaty's constraints), and European financial institutions had not yet been exposed as holders of American toxic debt. The euro surged from $0.86 in February 2002 to $1.60 in July 2008 — an 86% appreciation.
For the dollar's reserve currency status, this was the most serious challenge in decades. Central banks began diversifying their reserves away from dollars and toward euros. The dollar's share of global reserves fell from 71% in 2001 to 62% in 2008. For the first time, serious economists began debating whether the euro might eventually replace the dollar as the world's primary reserve currency.
| Year | DXY | Change | Fed Funds | EUR/USD | Key Event |
|---|---|---|---|---|---|
| Feb 2002 | 119.6 | — | 1.7% | $0.87 | Dollar's last peak; slide begins |
| 2002 | 106.4 | −11% | 1.2% | $1.02 | Iraq buildup; corporate scandals (Enron, WorldCom) |
| Mar 2003 | 99.2 | −7% | 1.3% | $1.08 | Iraq invasion begins March 20 |
| 2003 | 89.7 | −10% | 1.0% | $1.26 | Fed at 1%; euro surging; dollar freefall |
| 2004 | 82.0 | −9% | 2.2% | $1.35 | Fed starts hiking; dollar still falling |
| 2005 | 91.9 | +12% | 4.2% | $1.18 | Brief rally on higher rates; housing booming |
| 2006 | 82.4 | −10% | 5.0% | $1.32 | Fed at 5.25%; subprime cracks emerging |
| 2007 | 75.7 | −8% | 4.2% | $1.46 | Subprime crisis; Fed begins cutting; dollar accelerates down |
| Apr 2008 | 71.5 | −6% | 2.3% | $1.60 | All-time DXY low: 71.54 on April 21 |
| Jul 2008 | 72.3 | +1% | 2.0% | $1.58 | Oil at $145; Bear Stearns already failed |
| Dec 2008 | 86.8 | +20% | 0.2% | $1.40 | Lehman bankrupt; dollar surges on safe-haven panic |
The final line of the table contains the twist that nobody predicted. When Lehman Brothers collapsed on September 15, 2008, and the global financial system came within hours of complete shutdown, the dollar — the currency at the center of the crisis, the currency in which the toxic mortgage-backed securities were denominated — surged 20% in three months.
The dollar's safe-haven reflex overpowered everything. When the world's financial system was collapsing, investors didn't care that the crisis was American-made. They wanted the deepest, most liquid market on the planet. They wanted Treasury bonds. They wanted dollars. The long slide from 120 to 71 ended not because the dollar's problems were solved, but because everyone else's problems were suddenly worse.
The dollar's six-year decline from 120 to 71 was driven by choices — the choice to fight two wars on borrowed money, the choice to hold interest rates at emergency levels long after the emergency passed, the choice to allow an unregulated financial system to manufacture trillions in mortgage securities that would turn toxic. Each choice weakened the dollar incrementally; together, they produced the worst depreciation in its history.
But the crisis also revealed the dollar's most powerful attribute: there is no alternative. When the financial system collapsed, the world didn't flee the dollar — it fled to the dollar. This paradox — that the currency at the center of the crisis was also the safe haven from the crisis — would define the next decade. The Federal Reserve was about to embark on the most radical monetary experiment in history: quantitative easing. The question was whether printing trillions of new dollars would finally break the reserve currency's spell.