Question

During the U.S. financial crisis of 2007 the U.S. government pursued an expansionary macro economic policy. The role of government expanded and huge sums of money was pumped into the economy. On top of that the Federal Reserve lowered interest rates to historical lows in order to create liquidity in the credit markets. The Fed's action of pumping $600 billion gradually into the economy was met with much skepticism from Asian and European nations.

At the time, Germany stated the United States is forcefully lowering the value of the dollar by pumping more money into the economy and the Fed's action is no different than China manipulating the yuan. The EU feared the U.S.'s monetary easing will put increased pressure on weak European economies (the PIIGS - Portugal, Ireland, Italy, Greece, & Spain) and cause their currencies to appreciate in relation to the dollar.

Emerging market nations (India, China, Vietnam, Thailand, and South Korea) believed the lowering of the value of the dollar would cause huge captial inflows that risked creating inflation in their economies.

Was Germany and Europe's concerns valid? Should the rest of the world fear the possibility of the dollar being valued less than their home currencies?

Answer 1

Due to Federal Reserve's expansionary monitory policies the flow of dollars in the market is high, or the liquidity is high, now when the liquidity is high, the demand for dollars in the international market will fall which results in devaluation of dollars.

Germany's and Europe's concerns are valid because devaluation of dollar will distroy the local industries, as the value of dollars fall the imports from US to this nations will increase, US products will become more competitive thus increasing pressure on the weak economies.

Also there is increase in FDI in the emerging market nations, which may hamper the small scale industries of this nations, it can also worsen the unemployement situation in this developing countries.

Rest of the world feared because the recession has domino effect on many economies worldwide, and the Federal Reserve's expansionary policy over a long time, led to higher liquidity, resulting in large accumulation of dollars in developing economies, as it is a global reserve currency.