The situation is like a carnival fun house where most end up disoriented and can no longer tell which way is up. A falling Dollar and Euro is bad news for China's Dollar and Euro holdings, and bad news for their exports. Can China neutralize "quantitative easing" policies? Probably not, but the general bond buying public will in time.
FDR devalued the Dollar 30% with the stroke of a pen, by raising the Dollar price of gold from $20.60 to $35 an ounce. This was effective in stimulating demand for U.S. products for a long period of time because many European and other nations did not devalue their currencies, or did so only after a long delay. Today we have to do this differently.
G-nations (Europe/US etc) have decided to put into effect "quantitative easing". In practice this means each industrialized nation buys their own debt, and each other's debt, with newly created money. This Reuters article explains this more fully.
One way this is put into effect is with a "currency swap". As an example, the Fed gives the European Central Bank $1 Trillion and they provide an equivalent value of Euros. The Fed can buy European debt with these Euros and the European bank can buy U.S. debt with the U.S. Dollars wired to them by the Fed.
While the U.S. Treasury will need to sell $2 trillion of Treasuries over the next year . . . the Fed will buy an equal amount of debt with new money. The Fed will buy $300 billion of long dated Treasuries, $1.25 trillion of Mortgage Backed Bonds, and $200 billion of Fannie Mae and Freddie Mac paper along with other bits.
Notice the total debt purchases are weighted toward lowering mortgage rates, ie narrowing the spread between Treasuries and Mortgage paper.
So why are long rates rising? As the article mentions, this could be the Chinese and others selling, so central banks have to buy debt even faster to keep rates down.
Our biggest import problem will be oil prices. Oil is rising in Dollars, as the Dollar declines, but the price of oil is also dependent upon global economic activity, which will continue to decline. So longer term, expect any economic rebound to be killed-off by higher oil prices.
The larger problem with declining currency values is "competitive devaluation". Those nations outside of the G-zone will not like deflation being exported to their economies, as their exports decline and their people import more products from the U.S. and Europe G-zone, so in time they will also take measures to push down their currencies as well.
Competitive devaluations will neutralize the economic advantage of the lower U.S. Dollar, but total US debt will still be reduced by the devaluation by effectively stealing value from those who hold U.S. Dollars - by repaying debt with Dollars worth far less than those borrowed.
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