Question

Part of international trade involves countries using their money to purchase other countries currencies, invest in their stock markets, and purchase financial products such as US treasuries (bonds, debt). In August 2002, a private lawsuit was filed in U.S. courts which sought to seize over $1 trillion worth of Saudi Arabian and other Middle Eastern assets in the United States as compensation for terrorist attacks. If the lawsuit would have been successful, how would that have affected future foreign investment in the United States? How would it affect interest rates?

Answer 1

Solution

If the above stated lawsuit has been successful it would adversely affected the foreign investment in the United States.

The $1 Trillion worth of Saudi Arabian and other Middle Eastern assets in the United States would become the assets of the United States.

Since the ownership of the U.S assets will be transferred from the foreign to the U.S government,the U.S economy will benefit financially in the short-term but in the long-term it will suffer as the foreign investments will stop coming to the US from the foreign countries across the globe as they will believe that this may happen in their case even if similar situation occurs in the future.

So,in the long-term the US economy will suffer in terms of reduced / no foreign inflows i.e., other countries will not purchase the US assets.So,the demand for dollar in the international foreign exchange market will reduce by a margin which leads depreciation in the value of the dollar in relation to other currencies across the world.

So the value of goods imported into the US from other countries across the world increase.

We already know that the exports of US are lesser than it's imports.So,the prices of the goods in terms of the US Dollars will increase.This will lead to inflation.

When there is inflation,the interest has to be an increase in order as a counter to it.Because when there is inflation,people tend to hold more money in their hands due to increased prices and also the existing interest rates are not encouraging them to save as the value at which their money is appreciating becomes less encouraging / irrelevant to them.

So,initially the interest rates will be low as the US is a developed economy.But ultimately,the interest rates will be increased by the federal reserve to control the inflation rate.

When the interest rates increase,the US economy will start to become more encouraging for more foreign investments BUT due to the above issue related to asset acquisition,the investment suffers.