Extreme volatility returned to the U.S. Treasury market on Wednesday as long Treasury bonds declined as much as 2 points in reaction to the selling of dollars in the foreign exchange market by several foreign central banks. The theory that if the dollar comes down too quickly, interest rates will rise was finally tested, and, on that particular day, the theory became fact. However, the events behind this bizarre intervention into the foreign exchange market and the panic in the government market has many nuances.

For one, real confusion existed from Fed Chairman Paul A. Volcker's testimony of two weeks ago before the Senate Banking Committee when he stated that he was not worried about the rising dollar. Foreign exchange speculators, commercial banks and multinational corporations took heart from the chairman's statement and were encouraged -- to their way of thinking -- to buy more dollars, which fueled the continuing advance. Until the 26th of February, the dollar had advanced 16 of the last 18 days and was reaching new highs daily.

At the same time, other factors were emerging. Short-term credit growth had jumped 16 percent during the past four weeks, while the growth in the money supply continued to expand along with the economy. Perhaps the Federal Reserve felt that it was loosing control of the situation because Volcker, in this past week's testimony before Congress, said, in essence, that the strong dollar was inhibiting the Fed's ability to tighten credit. He also added that recent foreign central bank attempts at intervention in the foreign exchange market had not been forceful enough. This set the stage for the "group" intervention into the foreign exhange market with the sale of some $1.5 billion to $2.0 billion dollars. Interestingly enough, it is perceived that some of the central banks sold Treasuries to the Fed to obtain dollars to sell into the foreign exchange market.

At any rate, from Chairman Volcker's new remarks and from the central banks' massive sales, investors arrived at two conclusion. First, that if the dollar fell in the foreign exchange market, the Fed would be in a position to tighten credit. And second, if the dollar was going to decline in value, and if interest rates were going to rise -- which would mean lower bond prices -- then it was time to take profits in the dollar, and, for bond dealers, it was time to sell bonds and try to save one's skin. It was particularly gruesome for the bond dealers, as they still had large positions acquired in the five recent bond auctions, all of which were "underwater" even before the intervention occurred.

This week's events raise several questions. Is the Federal Reserve losing control of the situation as another global dimension becomes significant in the equation for managing the U.S. economy? Is the Federal Reserve in a box? If the Fed attempts to lower rates, then it chances heating up the economy and an increase of inflation. And lower interest rates and a declining dollar could stop the inflow of dollars from abroad, which have helped to finance our budget deficit and have helped our economic recovery. Or, if the Fed attempts to rein in credit and the economic expansion, interest rates will rise and, with them, the value of the dollar, which is killing our exports.

Lastly, will the efforts of the central banks be successful or will they have to continue selling dollars to protect their currencies? Most analysts feel the dollar will continue to rise, although much more slowly, because, after all, it's still the only viable game in town. Until the dust settles, short-term securities seem to be a wise investment.