At this point it is appropriate to examine the net result of the foregoing seven transactions on the short-term claims of u.s. residents and of foreign residents. As the table shows, these transactions have involved almost the same volume of debits as credits to U.s. private short-term claims on foreigners, with the net result that these claims have been diminished ( credited) by $1 million (the figure on line 21 in the last column). By contrast, as shown on line 24, foreign private short-term claims on this country have risen by $50 million (excluding the effects of transaction 8, which remains to be discussed).
It happens that all of this $50 million is in the form of demand deposits, and private foreigners might not wish to retain all of these newly acquired dollar balances. Those who hold demand deposit dollar balances typically do so for purposes such as financing purchases from the United States (or from non-U.S. residents desiring dollars), and there is no guarantee that such motivations will be just strong enough to make the dollar-balance holders exactly satisfied with the $50 million increase in their holdings. For purposes of illustration, assume that foreign residents attempt to sell $40 million of this increase in exchange for balances in their native currencies, but that U.S. residents do not want to trade any of their foreign-currency balances for the proffered dollar balances at the going rates of exchange between the dollar and foreign currencies. In these circumstances the foreign-exchange value of the dollar (the price of the dollar in terms of foreign currencies) will decline.
However, some central banks might hold the view that the foreign-exchange value of their currencies was inappropriately high (i.e., that the foreign-exchange value of the dollar was inappropriately low), in which case they might sell foreign currencies in exchange for dollar balances in order to moderate the decline in the exchange price of the dollar. In the present case, suppose that foreign central banks purchased 25 million in dollar balances from commercial banks within their territories. The U.S. balance-of-payments accounts would register an increase of $25 million in U.S. liabilities held by foreign monetary authorities (line 23) and an equivalent decrease in short-term liabilities held by private foreigners (line 24).
It should be noted that such purchases of dollar balances by foreign central banks supply the commercial banks that sell the dollars with new reserves in their native currencies. In general, these reserves can be used by the banks to expand the loans and thus to inflate the money supplies in the countries concerned, if nothing else is changed.
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