Since you mentioned me a few times, I guess I sort of have to respond. First, I will say that I’m not going to make any predictions on what will happen to the U.S. dollar in the immediate future as I’m honest enough to admit that I would only have a 50% chance of being right.danmand said:
You are right when you describe the immediate effect on interest rates. However, I’m not sure your logic on the effect on the U.S. dollar immediately follows. Normally an increase in interest rates leads to an increase in the value of a currency. However, this is because when interest rates in country A increase and they stay the same everywhere else, people sell bonds in other countries and by bonds in country A. To do so, they have to sell other currencies and buy American dollars (to pay for American bonds). This forces up the value of the American dollar. The process continues, until the exchange rates and interest rates have adjusted so the expected return from buying an American bond is the same as the return from buying a foreign bond (ignoring considerations like risk premiums). I gather from your post that you already know this and are thinking in these terms.
However, I’m not sure that your scenario is the same. In your case, causation is reversed. Instead of foreigners buying U.S. bonds to get a higher return, you’re describing a foreign country selling U.S. bonds and thus leading to a higher American return. The act of selling U.S. bonds would involve China selling American dollars (assuming they don’t just want to hold American currency that pays no interest) and buying some other currency for investments elsewhere. That should lead to a decrease in the value of the American dollar.
To be honest with you, this is completely outside of my area of specialization. Thus, I could be missing something in your argument. However, I’m not convinced but I do admit that you do make a much better economic argument then is standard on terb.
