Interest rates are one of the main tools in order to guide the economy.
By raising interest rates, consumer spending slows, and inflation is kept in check.
By lowering interest rates, consumer spending increases and the economy tends to run faster, unemployment tends to fall and the dollar tends to lower in value.
This lever has another side effect. The value of the currency tends to rise and fall as the interest rate is increased and decreased. This is because if the interest rate is raised one can gain a higher return on interest.
As the interest rates in Australia have risen, so has the value of the Australian dollar. But anyone who buys Australian dollars now also has a risk that the currency will subsequently decrease and the capital loss suffered will eat into the interest rate returns.
What happens however when there are two separate currencies which are essentially pegged (like China and the US). If the US raises interest rates then borrowers in China can make money for nothing by lending in the US without any serious risk of capital loss.
Is this essentially whats been happening in recent years and the reason why China continued to lend so much money to the US?