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Q119 (CAPF/2011) Economy › External Sector & Trade › Exchange rate dynamics Answer Verified

There is a growing internal financial crisis in the US with the possibility that there will be de-valuation of the dollar. Which amongst the following countries is/are most affected ?

Result
Your answer: —  Â·  Correct: B
Explanation

A devaluation or significant depreciation of the US dollar most severely affects countries with the largest holdings of dollar-denominated assets and foreign exchange reserves. China holds the world's largest foreign currency reserves, exceeding $3 trillion [t5]. A substantial portion of these reserves is invested in US Treasury securities because the US treasury market is the world's most liquid bond market [t2][t5]. If the dollar devalues, the value of these massive holdings in terms of purchasing power or other currencies decreases, leading to significant capital losses for the holding nation [t2]. While Japan also holds over $1.1 trillion in reserves [t5], China's total exposure and its role as a primary creditor to the US make it the most affected. Furthermore, China's trade surplus with the US means it continuously accumulates dollars that must be reinvested, deepening its vulnerability to dollar volatility [t2].

Sources

  1. [1] https://www.investopedia.com/articles/investing/040115/reasons-why-china-buys-us-treasury-bonds.asp
  2. [2] https://www.cfr.org/backgrounder/dollar-worlds-reserve-currency
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