China Pegs to Dollar to Keep Trade Imbalance

For the sake of simplicity, let's assume that the current conversion rate is 6 Chinese Yuan per 1 US dollar.
And at that exchange rate, China is exporting 50 million dollars worth of goods to the United States.
And the U.S. is exporting 20 million dollars worth of goods to China.
So clearly, there is a trade imbalance; the U.S. is importing 50 millions dollars worth of goods.
And it's exporting 20 million dollars worth of goods.
So it has a 30 million dollar trade deficit.
Now in this situation, the Chinese manufacturer is going to have 50 million dollars that it's going to
want to convert from its revenue in America and convert that to Chinese currency.
The American manufacturer is going to want to convert its Yuan into 20 million dollars.
So the supply of dollars which is this 50 million right over here is going to be much greater
than the demand which is the 20 million dollars.
So if the currencies were allowed to float, the dollar would weaken.
The cost of the dollar would go down, it's supply is so much bigger than the demand.
But let's say that the Chinese central bank does not want that to happen.
So this is the People's Bank of China.
They do not want the Chinese currency to strengthen because if that were to happen then Chinese goods
would become more expensive in the United States and it would be harder to maintain this trade imbalance - they want it.
So what they do is essentially make up for the difference in the demand for the dollar.
Right here, there is only demand for 20 million dollars, there supply of 50.
So what they do is create demand for 30 million dollars.
And the way that they create demand for 30 million dollars at that exchange rate is that
they can literally print (create) 180 million Yuan,
and then at an exchange rate of 6 to 1 they can go out into the open markets.
And try to convert this into dollars.
And so this would create demand for an incremental 30 million dollars.
And so when they do that the total demand for dollars is their 30 million plus the 20 million dollars
from the American manufacturer that will completely equal the supply of dollars at that exchange rate
and so it will not cause the exchange rate to fluctuate or the balance of trade to change.
So this is clearly a very simplified example;
the actual numbers are much larger than in the millions: they are in the hundreds of billions of dollars,
but this gives, at least in my mind, a respectable idea of how the Chinese central bank is actually keeping
its currency pegged to the dollars and how that's helping to maintain a trade imbalance.
This is Salman Khan of the Khan Academy for CNBC.