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Related topics: currencies, inflation, gold, Federal Reserve, dollar

Sovereign debt worries continue to ripple along the periphery of the eurozone. The European Union and the International Monetary Fund have stepped in to rescue Ireland and Greece. And the first aid may not be done. Portugal, especially, looks vulnerable.

And yet the euro has recently put in a strong run against the dollar. It now trades at $1.37, up 1.7% for the year against the dollar and well above the $1.20 it hit during the height of the Greece crisis early last year.

As Europe grapples with rescue packages and debate about the euro's future gains intensity, it's somewhat surprising that the euro is doing so well.

Traders are actively trying to discern whether the rise in the euro is something that will persist, or if it's a mere blip before the dollar makes its comeback.

Currencies are a funny business. Trading is huge at about $4 trillion in daily volume, according to the Bank for International Settlements. That activity is the product of companies making transactions in a globalized world, as well as speculators trying to profit from pinning a value on the euro, dollar, Japanese yen, Swiss franc, British pound and Polish zloty, among many other currencies.

And this market scarcely existed 50 years ago. Previously, currencies had mostly been pegged to gold, either directly or through a relationship with another currency, usually the dollar. But as the gold standard broke down in the 1960s and early 1970s, currencies began to "float" freely, with markets setting their value.

How do markets decide the value of a currency? Several factors matter, such as economic growth and prospects, the state of the fiscal ledger, inflation and interest rates.

According to theory, currencies move to alleviate global imbalances. In practice, that is not always the case. Some countries, like China, like to keep currencies low, because a weaker currency makes their exports more competitive against goods from countries with stronger currencies.

In the euro vs. dollar battle, the rules of engagement mainly boil down to interest-rate expectations, with the European sovereign debt crisis and America's fiscal challenges as the big unknowns.

Higher short-term interest rates increase the value of holding a currency. When a country "defends" its currency, it raises short-term rates to lure investors.

Right now, both the Federal Reserve and the European Central Bank are maintaining rock-bottom interest rates. Thus, in the foreign-exchange markets, investors are looking to bet on which central bank will start raising rates first.

It's not an easy bet to figure, and that's been the case for some time.