The value of the USD has been falling dramatically against all major currencies. What is the likely future direction? Well, that's the billion dollar question.... literally. If I knew, I would not be writing it here, but would use my information to speculate on the currency! But alas, I'm not sure which way the dollar will move. (As I've argued earlier, part of the reason why we can't predict exchange rates well is the ease with which we can speculate on them). So instead, I'll write a blog entry about it!
I'm not alone. Menzie Chinn provides a very careful survey of academic thinking on the behaviour of exchange rates here, and ends up being about as non-committal as me.
For the record, I think we can predict the exchange rate with a little success. First, high interest rate bearing currencies tend to appreciate relative to low interest rate ones- the motivation for the "carry trade" (see my earlier posts here and here).
Second exchange rates tend to over-correct in the short run, like most other assets- thanks perhaps to "momentum traders" who tend to buy assets that are appreciating simply because they're appreciating, rather than due to underlying fundamental value. So ultimately someone will make a lot of money by buying USD at the bottom of the market. (That person will probably not be me, as we have no way of knowing when we're at the bottom until after the fact!)
And third in the long run, purchasing power parity is an important driver of exchange rates. Based on this, I still consider my earlier position to be reasonable: the USD will have appreciated a long wayt from its current value (and even its value as of 6 months ago) within 5 years.