Question: 1 How did China and Japan manage to weaken their

1. How did China and Japan manage to weaken their currencies against the dollar?
2. Why did the U.S. dollar and U.S. Treasury bonds fall in response to the G7 statement?
3. What is the link between currency intervention and China and Japan buying U.S. Treasury bonds?
4. What risks do China and Japan face from their currency intervention?

In early 1994, the U.S. dollar began a steep slide, particularly against the yen (see Exhibit 2.10), that ''baffled'' President Clinton. He believed that the U.S. economy was stronger than it had been in decades, and therefore the dollar's weakness was a market mistake. ''In the end, the markets will have to respond to the economic realities,'' the president said. His critics, however, described the dollar's travails as a global vote of ''no confidence'' in his policies. They pointed to President Clinton's erratic handling of foreign affairs (e.g., Bosnia, Haiti, Somalia, North Korea, Rwanda) and threatened trade sanctions against Japan and China, along with his administration's tendency to use a weak dollar to bludgeon Japan into opening its markets without any concern that dollar weakness could boost inflation. Investors also noted White House resistance to the Federal Reserve Board's raising interest rates to stem incipient inflation as well as President Clinton's appointment of two suspected inflation doves to the Federal Reserve Board. Even worse, the Clinton administration did not appear to be particularly bothered by the dollar's drop. In June 1994, the administration did and said nothing to support the dollar as it fell to a 50-year low against the yen. At a meeting with reporters on June 21, for example, Treasury Secretary Lloyd Bentsen rebuffed three attempts to get him to talk about the dollar; he would not even repeat the usual platitudes about supporting the dollar.

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