Question

Much of the U.S. government debt is held by foreign investors as treasury bonds and bills. How do fluctuations in the dollar exchange rate affect the value of that debt held by foreigners?

Short answer

When the value of currency appreciates, the borrower will have to pay less and when value of currency depreciates, the borrower will pay more.

Step-by-step solution

Step 1. Introduction

Currency exchange rate fluctuations have an impact on the economy because a weaker currency makes imports more expensive, while a stronger currency stimulates exports by making them cheaper for overseas buyers to buy. Over time, a weak or strong currency can contribute to a country's trade deficit or surplus.

Step 2. Explanation

Fluctuations in the dollar exchange rate have a direct impact on the value of foreign debt held by foreigners by affecting the value of the money owed by the government to debtors. Assume that one US dollar equals 20 pesos. When the exchange rate falls, the dollar loses its purchasing power and can now only buy 15 pesos. Investors who own these bonds are paid in less valuable dollars, lowering the value of the debt they owe. The opposite is true when the exchange rate rises. Virtually, the dollar will be exchanged for 25 pesos and investors will be paid in more valuable dollars. This enhances the value of what they owe.