Case Number Three: The U.S. Dollar Sells Off On September 3, 2003, the finance ministers of the Group of Seven (G7) industrialized countries endorsed flexibility in exchange rates, a code word widely regarded as an encouragement for China and Japan to stop managing their currencies. Both countries had been actively intervening in the foreign exchange market to weaken their currencies against the dollar and thereby improve their exports. China and Japan had been seen buying billions of dollars in U.S. Treasury bonds. The G7 statement prompted massive selling of the U.S. dollar and dollar assets. The dollar fell 2% against the yen, the biggest one-day drop that year, and U.S. Treasury bonds saw a steep decline in value as well.

Questions

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?