In order to maintain
a trade imbalance we know that the Chinese
central government needs to keep its currency
artificially weak. And to do that they essentially
can print their currency and use that to buy US dollars. So what they do is they
increase the supply of yuan and they increase the
demand for dollars, keeping their currency weak. Now, the next
question you might ask is what do they do
with the actual dollars that they bought with the
yuan that they printed. Well, they don't want to
just sit on those dollars. They'd prefer to be collecting
some type of interest on that money. So instead of just
keeping it all in some warehouse
someplace they actually just lend that money
to the US government. And they lend that money by
buying US Treasury bonds, by buying T-bills and T-notes. So that money that they use that
they bought with their printed yuan, that goes to
the US Treasury. And the US Treasury gives the
Chinese Central Bank treasury bonds. So these are treasury bonds. Now, what's the effect of this? Clearly, the Bank of China is
getting interest on its money now. It's helping to finance
the US government's debt. But maybe even
more interestingly, it is creating incremental
demand for T-bonds, for treasury bonds. Now, what does that do? Well, if you're increasing
the demand for anything that's also going to
increase the price. So the price of treasury
bonds, of T-bills and T-notes, goes up. T-bills are durations
less than one year. Notes are durations
more than a year. So the price goes up. But what happens if
the price goes up? That means that the interest
that the government has to pay on this debt goes down. And I explained that in
more depth in other videos. Now, the interest goes down. That means that the cost of
borrowing for the US government goes down. But that's also
the benchmark rate for the cost of debt in general. So in general it finances US
debt, both of the government and really just
credit more broadly. So debt becomes cheaper
inside of the United States. This is Salman Kahn from
the Khan Academy for CNBC.