Review of China US currency situation
About this video
Sal reviews the whole China-US currency picture with the microwaves and software example at 6 yuan per dollar. A floating rate would weaken the dollar and fix the imbalance, but the People's Bank of China prints yuan to buy dollars instead. It lends those dollars out, which lowers US borrowing costs, encourages more consumption, and ends with Americans buying even more Chinese microwaves.
You'll be able to
- explain what a floating rate would do in the microwaves and software example.
- describe how the People's Bank of China keeps the yuan weak.
- explain how lower US borrowing costs lead to more purchases of Chinese goods.
Key words
- Floating exchange rate
- A rate set freely by supply and demand for currencies.
- People's Bank of China
- China's central bank.
- Borrowing costs
- The interest paid to borrow money.
- Supply of loans
- How much money is available for people to borrow.
Transcript
Let's review how China can maintain a trade imbalance with the United States by artificially keeping its currency weak. So we had a simplified scenario where we had an exchange rate of 6 yuan per $1. We had a Chinese manufacturer selling $50 million worth of microwaves in the United States.
We had a US software producer selling $20 million worth of software in China. If we had a floating exchange rate, the supply of dollars is much greater than the demand for dollars. So the dollar would become weaker. It would become weaker, and the yuan would become stronger.
And that would resolve the trade imbalance We saw that the People's Bank of China does not want that to happen. So what they do is they artificially create demand for dollars to keep it strong. They do that by essentially just printing yuan and converting it to dollars.
And that obviously also increases the supply of yuan, so it makes that less expensive. It weakens the yuan, strengthens the dollar. Now, they're not just going to sit on literally cash with those dollar bills. They'll actually want to lend to them out. So what this does is it increases the supply of money for loans, supply of loans.
Well, if you increase the amount of dollars that can be lent, that's going to lower the cost of borrowing dollars. So the effect is you are lowering borrowing costs. And if you're lowering borrowing costs that just means interest is less, and it's easier to use your credit card, either if you're the US government or if you're the US consumer.
Now, if debt becomes cheaper or we have lower interest rates-- If you have a lower interest rate on your credit card that means that you're just going to consume more. So the end result, the big picture of what's happening here, in order to maintain a trade imbalance, in order to keep its currency peg, you have the Chinese Central Bank essentially printing money, converting it to dollars, and then lending that to the US government and consumer, and what are they going to do with it?
Essentially, they're going to end up buying more Chinese goods. In our simplified example, they'll buy even more microwaves. This is Salman Khan of the Khan Academy for CNBC.
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