Final answer:
During global uncertainty, the demand for U.S. dollars increases as investors seek safe assets like U.S. Treasury bonds. However, if U.S. interest rates fall relative to other countries, the demand for dollars decreases while the supply increases, leading to a depreciation of the dollar. Increased U.S. borrowing can reverse this trend if foreign investment in U.S. bonds increases.
Step-by-step explanation:
If U.S. Treasury bonds are considered a safe asset during times of global uncertainty, the demand for U.S. dollars will increase when uncertainty rises elsewhere in the world. Investors tend to move their capital into safer assets, often buying government bonds from politically stable and economically strong countries such as the United States.
Now, let's suppose U.S. interest rates decline compared to the rest of the world. We would likely see a decrease in demand for dollars since lower interest rates make U.S. assets less attractive. Investors seeking higher returns would look to countries with higher interest rates.
Concurrently, there would be an increase in the supply of dollars in foreign currency markets as investors sell their dollars to invest elsewhere. As a result, the exchange rate for dollars, especially compared to stronger currencies like the euro, is expected to depreciate.
However, if the U.S. government increases borrowing from European financial investors to fund its bonds, these investors will need more U.S. dollars, increasing demand and decreasing supply on foreign exchange markets. This could lead to an appreciation of the U.S. dollar relative to the euro.