Currency Effect on Trade Review Currency Effect on Trade Review
Currency Effect on Trade Review
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- Let's review what happened in the last video because, in general, it's just kind of confusing
- and it's always good to see it a second time.
- And then we can think a little bit about how these market dynamics could be manipulated
- so that you don't have the Chinese currency getting more expensive.
- So in the last video, we started off with an exchange rate of 10 Yuan per (US) dollar.
- We saw that this manufacturer over here in China had to sell his goods
- for the equivalent of 10 Yuan in order for him to make a profit;
- and that this guy in United States had to sell his goods abroad --
- or we'll say in China -- for the equivalent of $1.
- Now this exchange rate, this price was $1, one US dollar in the United States.
- And at this exchange rate, this guy had to sell his cola for 10 Yuan so that he could get his dollar.
- So we kind of just drew it out.
- And we said at that price --
- So for 10 Yuan -- which was $1 -- at $1, there was demand for 100 dolls in the United States.
- So we saw this dynamic.
- He would ship 100 dolls to the United States;
- and then the United States would ship him back $100.
- He would sell those dolls for essentially $1 each; he would get back $100.
- On the other side of the equation, the cola manufacturer
- if he were to sell it for 10 Yuan in China, there's demand for 50 cans of soda.
- So he would send 50 cans of soda to China; and they would send him 10 Yuan for each can: 500 Yuan.
- Now, what happened in that situation is that
- the Chinese manufacturer had 1,000 Yuan that he needs to convert into dollars --
- into $100 preferably -- if that exchange rate were fixed.
- The American manufacturer -- and let's say that these are the only two actors in our scenario --
- has 500 Yuan that he needs to convert into $50.
- So if we just look over here, here's someone who wants to convert (into) 1,000 Yuan.
- He wants to convert (his dollars) into 1,000 Yuan.
- Let me be very careful.
- He wants to convert his $100 into 1,000 Yuan, if the currency were to be held constant.
- But there's only 500 Yuan being offered in the market.
- So he was going to have to offer more dollars per Yuan than he would if there were more Yuan in the market.
- Now you can look at it from the other side.
- This American manufacturer has 500 Yuan from his sales in China.
- He wants to convert it -- if the currency was pegged -- into $50.
- But maybe he could do better than $50 here.
- And as we can see, there's more demand to convert the Yuan than there is to convert the dollars.
- He wants to buy $50 using Yuan.
- This guy wants to sell $100 (to convert it) into Yuan.
- So if you look over here, the supply of dollars is much greater than the demand for dollars.
- And you know in anything, if the supply of apples is greater than the demand for apples
- then the price of apples would go down.
- And the opposite is happening here with the Yuan.
- The demand for Yuan -- this is the demand -- is much greater than the supply of Yuan.
- And we know that when the demand is greater than the supply, the price needs to go up.
- And so we saw a scenario where the price of the dollar will go down in terms of Yuan.
- Now all that means is if you were having to give 10 Yuan per dollar, now you're going to have to give fewer Yuan per dollar.
- The price of the Yuan would go down.
- If the price of apples in Yuan goes down, instead of offering 10 Yuan per apple, you'd probably offer 8 Yuan per apple.
- So we see the exact same thing for the price of the dollar.
- But that's equivalent to saying the price of a Yuan goes up.
- Now we said eventually -- and I'm just making this number up --
- it's hard to predict what the actual settling price would be -- we eventually get to 8 Yuan per dollar.
- And then we said, at that exchange (rate) --
- and actually I'm going to change the numbers a little bit, just to make it a little bit cleaner --
- at that exchange rate -- at 8 Yuan per dollar -- these 10-Yuan dolls would now cost $1.25.
- And let's say that at $1.25, in the United States, there is demand for 60 dolls.
- (I'm changing the numbers a little bit from the last video just to make the numbers work out a little bit better.)
- So you can just ignore the numbers from the last video.
- And remember, the old demand, when the 10-Yuan dolls were only $1 -- (WRITING) so the old demand was 100 dolls --
- So it makes sense -- If dolls are $1, people are going to have more of them.
- If dolls go up to $1.25, the demand will go down -- and let's say it'll go down to 60 dolls.
- Now on the other side of the equation, the $1 can of soda at 8 Yuan per dollar will now sell in China for 8 Yuan.
- And remember what the old price was.
- The old price in China -- where the currency rate was 10 to 1 -- was 10 Yuan.
- So the price -- let me write it here -- the price of the cola went from 10 Yuan down to 8 Yuan.
- So the demand, now that the cola is cheaper in China, the demand went up.
- And I'll change this number too, so don't do the 80 cans.
- We'll say that the demand in China went from 50 cans -- we saw that up here --
- he had to ship 50 cans when it cost 10 Yuan per can --
- So it went from 50 cans up to -- (WRITING) maybe I should make it go up
- the demand went from 50 up to, let's say, 75 cans.
- I'm using these numbers because it's going to lead to cleaner numbers.
- So now what is the actual scenario?
- In the last video I said work it out yourself,
- but I realize the more concrete examples of this (I can give you), the more it will kind of sink into your brain.
- So now what is the trade balance going on?
- So going from China, (WRITING) China -- and then you have the US
- Over here we're going to be shipping only 60 dolls.
- And then the U.S. is going to ship back 60 times $1.25.
- That is $75, right?
- $1.25 for 60 dolls means you're going to get $75.
- So 75 US dollars are going to go back to China.
- So that's due to the dolls.
- And now let's think about what's going to happen due to the soda.
- We are going to have -- 75 cans of soda are going to be shipped to China.
- And then China is going to send back 75 cans at 8 Yuan per can.
- 75 times 8 is -- it's 600.
- So for the 75 cans, he is going to get back 600 Yuan.
- So now what's happening?
- The Chinese manufacturer -- over here on the left -- wants or needs to convert $75 into --
- if we assume that the currency is now 8, and he says, well, I'll just get it at the market rate --
- into roughly 600 Yuan.
- 75 times 8 is 600.
- 8 Yuan per dollar.
- And then the U.S. manufacturer wants to convert--
- He's got 600 Yuan from his sale of soda, into --
- and, if he assumes he can get kind of the last market rate, 600 divided by 8 is into $75.
- So what just happened here?
- Now the supply of dollars is equal to the demand for dollars.
- And also, the supply of Yuan right over here is equal to the demand for Yuan.
- So now, depending on how you view it,
- we're sending the same dollar value to the US as we're sending back to China;
- or we're sending the same Yuan value to the US as we're sending back to China
- and the currency is now in balance. It really shouldn't shift.
- So I really wanted to go through this example again to show you that
- when you have freely floating currencies, eventually,
- one currency should get more -- if there is a trade imbalance,
- one currency would become more expensive than the other
- until the demand equalizes in both countries -- so that you eventually do have a trade balance.
- Hopefully that doesn't confuse you too much.
- In the next video, we'll talk about how a government --
- and we'll talk about the Chinese Central Bank in particular could intervene so that this doesn't happen
- so that they can always ship more to the US than the US ships to China.
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