Chinese Central Bank Buying Treasuries Chinese Central Bank Buying Treasuries
Chinese Central Bank Buying Treasuries
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- Let's review everything we've done in the last few videos
- and then take it a few steps from there.
- So let's say we have a reality that right now
- and this isn't the actual exchange rate, but I'm just using these numbers
- because they're nice simple numbers-- the current exchange rate is 10 yuan per U.S. $1.
- And now we're in a reality where the Chinese Government,
- the Chinese Central Bank, wants to keep this pegged
- so it wants to lock this.
- It wants to lock this exchange rate right over here.
- But the reality is, more is being sold to the U.S.
- more is being exported from China to the U.S. than the other way around.
- And so that leads to this weird dynamic that we've studied in the last few videos.
- So this is China right here, and then you have the United States right over here.
- And let's say at this exchange rate right over here,
- you have goods coming from China to the U.S.
- Actually, let me do it in that same magenta color.
- So these are Chinese goods, and then we are paying for those Chinese goods in dollars
- and those dollars are being sent to China.
- So let's say we pay in this time period.
- Let's say it's a year.
- Let's say that $100 sent to China for the goods
- and this is really just a summary of what we saw in the last few videos.
- And let's say, on the other side of this equation, some goods are sent from the U.S. to China.
- Some are exported, so U.S. goods are exported to China, and then we sell them in China
- and then we get some yuan in return that go back to the United States. And, of course,
- the reality is that the money seldom is actually sitting on a ship going across the Pacific.
- It's all in these bank accounts that can be wired back and forth.
- The actual exchanges are essentially happening on the internet
- not really in any physical location, but this is a good way to visualize it.
- So the U.S. goods are being sold in China and then the U.S. producer is going to get yuan.
- And let's say for their goods, they get 500 yuan.
- So if all of these people were just convert,
- and you actually don't know what the equilibrium price would be,
- because the demand changes depending on what the price is
- in each of the countries, but if you really wanted to convert these $100
- that the Chinese producer gets into yuan at 10:1, you would need-- so we're going to assume that
- this PEG is what at least the Chinese Government wants.
- So you would need 1,000 yuan in order to convert all of his $100 at 10 yuan per dollar.
- Now this producer, the U.S. producer, only has-- let me do it in a different color
- and I should put the quotes around needs, not around the yuan.
- Now this U.S. producer only has 500 yuan to convert into dollars
- and we've seen this multiple times.
- But I really want to reinforce it about how these currencies would fluctuate.
- The demand for yuan is much higher than the supply for yuan.
- And we could do the exact same argument for the dollar
- that the demand for dollars is much lower than the supply for dollars.
- At this exchange rate, if we assumed a PEG
- this would only be $50 that we need to convert into, while there's $100 of actual supply.
- But let's just focus on the yuan.
- They need 1,000 yuan at this exchange rate.
- There's only 1,000 yuan that can be converted into dollars.
- And if we had a floating exchange rate
- that would increase the demand for yuan, and then this number would go down,
- or another way to view it, either that number goes down or this number over here goes up.
- You could say the yuan would become more expensive
- which means maybe it's 9 yuan per dollar or 8 yuan per dollar, or it could go the other way.
- For 10 yuan, instead of $1, you'd get $1.10 or $1.20 or $1.30, either way.
- Now, in order for this lock and for this PEG to occur
- we saw in the last video that the Chinese Central Bank needs to intervene.
- Remember, where are the excess dollars?
- They're over here.
- Let me make it clear.
- There's $100 over here that need to be converted into yuan.
- We have 500 yuan over here that needs to be converted into dollars.
- Now, the Chinese government wants this $100 to be converted into 1,000 yuan.
- So what he does or what they do is they say
- OK, $50 of this $100 dollars can be essentially traded for these 500 yuan.
- Let me draw a two-way arrow there. $50 goes to the American producer
- and then the 500 yuan go to the Chinese producer in exchange for that $50.
- Obviously, this isn't coordinated.
- It's not like matchmaking.
- It's not like someone said, hey, you give this money to them.
- But essentially, there will only be $50 to convert into the yuan
- and then the other $50 will go to the Chinese Central Bank.
- Let me draw the Chinese Central Bank,
- and they will just print yuan and give another 500 yuan.
- And this is exactly what happened in the last video.
- I drew it a little bit different.
- All I'm showing is to make up for the lack of supply of yuan,
- they needed 1,000 yuan, there's only 500 yuan to convert.
- In order to make that up, the Chinese Central Government
- prints the extra Chinese currency and buys dollars with it.
- So it's essentially sucking up the excess dollars, right?
- This was excess dollars right over here so that the dollar does not weaken.
- It is sucking up extra dollars so that the supply for dollars isn't so high that it weakens
- or so that the yuan strengthens.
- And so that's the way the Chinese can maintain the trade imbalance.
- They could continue to export more goods than they are importing.
- Now, what is the effect of this, though?
- And we saw this.
- In order to maintain this currency PEG while there is this trade imbalance,
- the Chinese Central Bank keeps printing yuan and they keep accumulating dollars.
- And if they ever stop accumulating dollars,
- so it's not like they can just hold the dollars they have and the PEG will hold.
- If they ever stop accumulating dollars, then the PEG will break down.
- They have to do this every time period.
- They have to actively participate in the market
- printing yuan and buying dollars.
- They are doing it every day to maintain the PEG.
- Not every day, maybe sometimes when it won't fluctuate on their own,
- but if the yuan is getting expensive,
- they actually maintain a range, and they will buy dollars.
- So they're just accumulating more and more of these dollars.
- And now this is where it gets interesting.
- What does the Chinese Central Bank do with that cash?
- Now, like anybody, cash is useless.
- You're not getting any interest on it.
- It's just paper.
- It allows you to buy other things
- that could give you some income or could give you some value.
- So what the Chinese Central Bank does, it doesn't hold actual dollar bills.
- It goes and tries to buy the safest U.S.-denominated asset it can.
- And another thing, not only does it care about safety-- so it wants to go to a safe asset.
- It wants to go to the safe dollar-denominated asset,
- which means that you would buy it in dollars,
- and if it produces interest, the interest would be in dollars.
- And it's also doing this on a massive, massive scale, in the hundreds of billions of dollars,
- and actually the Reserve is in the trillions of dollars, so it's on a massive scale.
- So they can't just go buy a random company's stock, one that won't be safe,
- but also they would just drive the price up to infinity if they used this many dollars.
- So it has to be a very liquid asset,
- one that has a very deep market where the people trading in that market,
- it really is in the tens and hundreds of billions of dollars.
- And there's really only one asset that meets those requirements, and that's U.S.. Treasuries
- And this isn't the only thing they will do, but this is the great majority.
- So what the Chinese Central Bank does with all of these excess dollars,
- it essentially buys U.S. Treasuries.
- So it gives the dollars away.
- Well, not gives away, it sends the dollars to the people who are holding the U.S. Treasuries,
- and then it gets U.S. Treasuries in return.
- Now, as a bit of review, and I've done a few videos on this, what are U.S. Treasuries?
- U.S. Treasury bills and bonds are loans to the Federal Government.
- So that's maybe how you should view it.
- These are loans to the Federal Government.
- These bonds, these Treasury bonds or these treasury bills that they're getting,
- these certificates, are essentially-- in fact, they are-- IOUs from the U.S.A,
- not to get cheesy with the acronyms. These are literally IOUs from the U.S. Government,
- and the U.S. Government will pay interest. They are essentially--
- so just to make it all clear of what's going on,
- they're printing money. They're accumulating dollars.
- They're using those dollars to go out into either the open market
- or even directly from the Treasury, from the U.S. Treasury, and they are buying U.S. Treasuries,
- which essentially means that they are lending this money to the U.S. Government.
- Now, I'll leave you there in this video,
- and maybe you want to think about it a little bit before you even watch the next one.
- But in the next one, we'll talk a little bit about what that even means.
- What happens if you have this big holder of U.S. dollars,
- this huge holder of U.S. dollars going out there and
- buying Treasuries and being willing to lend money to the U.S. Government?
- Think about it.
- And in particular, think about what would happen to interest rates
- and what those low interest rates' impact would
- have on the rest of the U.S. economy and on debt in general.
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