Pegging the yuan

0:00In the last video, we saw a reality where the currency between, or the exchange rate between, the Yuan and the dollar started off at 10 to 1. And at that exchange rate, China was shipping more goods-- in terms of whether you measure it in dollars or Yuan --was shipping more to the U.S. than the U.S. was shipping to China.

0:22And because of that, we saw an imbalance in the currencies. The Yuan became more expensive, or the dollar became cheaper, until eventually Chinese goods got expensive enough that there was less demand in the U.S. and U.S. goods got cheap enough, that there was more demand in China, that the trade actually came into balance.

0:42Now, that's OK if everyone wanted to have balanced trade, but what if the Chinese government didn't want that. They said, hey, we needed to develop, the United States is already developed, we want to have an industrial base, we want to have a market to sell our goods to.

0:59We want to export more to the United States than we import from them. We want export-led growth. So they don't like the dynamic that they saw, they did not like the currency, they did not like the Yuan getting expensive. So let's say the Chinese government-- let me scroll up a little bit --so the Chinese government wants to keep currency exchange pegged at-- I ran out of space over there --at CNY 10 per dollar.

1:47And they want that because they want this situation to keep on going forever, that China keeps shipping more to the U.S. than the U.S. ships to China, or maybe they wanted to go even more, that China keeps shipping more and more to the U.S. than the U.S. ships to China so that China could build its industrial base.

2:04And, I guess the more sinister view is also so that the United States' industrial base gets depleted. That they keep manufacturing things cheaper and cheaper and cheaper, and then United States manufacturers can't compete. And we'll talk about this in more videos, it's not it's not clear that it's 100% one-sided.

2:23There's actually some benefits that the United States also gets from this, and we'll discuss that more. It's a little bit more involved. So how could they do this? Let's just say that the Chinese government wants this reality, and they want this reality frozen.

2:34They do not want the reality where the trade balances. How could they intervene in currency markets so that this doesn't change? Because, as we said, if more Chinese goods are being bought, there's more demand for Yuan, the Yuan should appreciate, the dollar should go down.

2:51But how do you get both? How do you have your cake and eat it too? How do you get more goods being shipped to the United States than back to China without the Yuan appreciating? And the way you do that, there's the Chinese government, or maybe in particular we could talk about the Chinese Central Bank.

3:09The Chinese Central Bank, which is a part of the Chinese government can say, hey, to keep our Yuan devalued, we will print money. So let me draw the Chinese Central Bank. Let me do this in a new color. And what they do, they can actually just print money. So we had this scenario that I had outlined in the last two videos where we had this imbalance.

3:53There was demand for CNY 1,000, but only supply of CNY 500. So what they can do is just equalize this. They could just print CNY 500 and then try to convert that into dollars. So what just happened? Now all of a sudden, we have $100 that are trying to be converted into roughly CNY 1,000 or if that exchange rate were to be constant.

4:34So there's demand for CNY 1,000. Before the Chinese Central Bank got involved, there was only a CNY 500 supply. But now the Chinese Central Bank says, OK, there's a demand for CNY 1,000, there's only CNY 500 supply, we're going to produce another CNY 500. We literally can just print it, and then they will convert what they printed into dollars.

4:55So just like that, you now have a balance of supply and demand. You have CNY 1,000, 500 here and 500 here that want to be converted into dollars, and then you have $100 that want to be converted into, I guess, CNY 1,000. So if they were to do this, the currency wouldn't change.

5:15The exchange rate would change. The supply and demand of the two currencies would be equal. Now, and that would work and frankly that's what they have been doing for some time now. But there's one kind of catch here. The whole time that they're doing this, what is happening?

5:35Well, they keep shipping more to the United States then the United States is shipping to China. These guys keep having to print Yuan and buy dollars with those Yuan in order to keep the Chinese currency cheap. So these people are going to keep accumulating dollars.

5:51They just keep printing Yuan and then they just keep accumulating dollars. Let me draw that over here, so the Chinese Central Bank just starts accumulating many, many dollars. They can they can print Yuan as much as they want, those Yuan, they trade them into dollars and then these guys start accumulating more and more dollars over here.

6:15And the more that they want this trade imbalance to occur, the longer they want it to occur, the more dollars that they will have to accumulate. So they have to just keep on doing it, they can't even stop doing it. They have to keep doing it in order to keep the trade balance the way it is.

6:27And in the next video, I'll talk about what they actually have to do with these dollars because they actually won't just keep it in cash, what they actually have to do with these dollars, and then what effect that actually might have on the United States economy.

6:39Then we could talk about how this might unwind itself, but we'll find out it's actually very difficult for this scenario to unwind once it gets started.