chapter  4
38 Pages

The Monetary System in the International Arena

The interest rate on a one-year Treasury bill in the United States is 2 percent and in Europe 6 percent. Provided that, in the absence of any significant news, markets do not expect a change in the dollar/euro exchange rate, US investors can increase their returns by selling US Treasury bills and buying European Treasury bills. In order to invest in Europe they must first change dollars into euros. The increased demand for euros causes an appreciation of the euro in relation to the dollar or, alternatively, the dollar depreciates against the euro. The rise in the value of the euro is now generating expectations of depreciation as markets now consider that the euro is overvalued.