The future of the dollar seems today to be the most important issue for the world economy in 2005. Is it overvalued or undervalued? Will it rise or will it fall? As you would expect any economist to tell you, it is both overvalued and undervalued, and it will go up and down.

The value of any currency is what it will buy. Purchasing power parity holds that a dollar has the same command over goods and services as the euros you could buy with that dollar. Purchasing power parity works well in explaining long-run currency movements and, over a decade or more, changes in exchange rates are mostly attributable to differences in inflation rates. But purchasing power parity is only a preliminary guide.