Let’s review how China can maintain a trade in balance with the United States
by artificially keeping its currency weak.
So we have a simplified scenario.
Where we have exchanged it of six Yuan per one dollar,
we have Chinese manufacturer selling 50 million dollars worth of microwaves.
In United States we have a US software producer selling 20 million dollars
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 trading balance.
We saw that the people’s bank of china does not want that happen.
So what they do is that they artificially create,
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 supplies of Yuan.
So it makes that less expensive.
It weakens the Yuan, strengthens the dollar.
Now, they’re not going to just sit on literally cash with those dollar bills
they’ll actually want to lend them out.
So what this does is increase the supply, 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 affect 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 for the U.S government,
or if you’re the U.S. consumer.
Now if things, if debt becomes cheaper if debt is cheaper.
Debt is cheaper.
Or we have lower interest rate if you have lower interest rate on your credit card
that means you are just going to consume more.
Consume more. So the end result,
the big picture what’s happen here in order to maintain a trade imbalance
in order to keep its currency pegged?
You have the Chinese central bank essentially, essentially lent printing money converting it dollars,
and then lending that to the U.S government and consumer
and what are they are going to do with it?
Essentially they’re going to end up buying more Chinese goods,
and our simplified example they’ll buy even more microwaves.
This is Salman Khan of the Khan Academy for CNBC
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