1. In addition to the mortgage and credits markets problems, there are two other issues that have kept the Fed Chairwoman sleepless at night. They are
i) The US budget deficit; and
ii) The huge foreign reserves surplus held by China, Japan, United Arab Emirates, Kuwait and other countries national banks that for months have mentioned that they will change their "investment strategies" (i.e. dumping US dollars for other currencies). Note: foreign reserves are foreign currencies held by a country national bank. Since the US dollar is the international currency, it is the biggest component of foreign reserves.
2. Please explain how each (budget deficit and foreign reserves) of the above noted economic issues affects long term interest rates and the inflation rate in the US.
(Hints: i) How does the US Treasury finance the deficit? And ii) What happens if other countries national banks decide to dump the dollar. One way of "dumping" the dollar is to sell US Securities and then use proceeds from the sale to purchase European sovereign debts?)