If interest rates are higher in the United States than in other countries, then investors WILL choose to invest in the U.S, increasing demand for the dollar, provided that the expected rate of inflation is not higher in the U.S than among our trading partners. If INTEREST rates are LOWER in the U.S than in other countries, investors will choose NOT to invest in the U.S, decreasing demand for the dollar.
If the US INFLATION rate is HIGHER, investors are LESS likely to prefer the U.S even with higher interest rates- because of the expectation that the value of the dollar will be ERODED by inflation. If our INFLATION rate is LOWER, investors are MORE likely to prefer the U.S, because there will be NO expectation that the value of the dollar will erode.
Trade balance also has an effect on a country's currency. If world prices for what a country exports rise in comparison with the cost of that country's imports, that country will be earning more for its exports than it pays for its imports. The more demand there will be for that country's currency, the better the deal becomes. If investors are confident that the U.S economy will be strong, they will be MORE likely to buy American assets, pushing UP the dollar's value. If investors are not so confident that the economy will be strong, they will be LESS likely to buy the country's assets, pushing the dollar's value DOWN.
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