For the sake of
simplicity, let's assume that the current
conversion rate is six Chinese yuan per
for one US dollar. And at that exchange rate,
China is exporting $50 million worth of goods to
the United States and the US is
exporting $20 million worth of goods to China. So clearly, there's
a trade imbalance. The US is importing $50
million worth of goods and it's exporting $20
million worth of goods. So it has a $30
million trade deficit. Now, in this situation,
the Chinese manufacturer is going to have $50
million that it wants 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. So the supply of dollars,
which is this $50 million right over here, is
going to be much greater than the demand, which
is a $20 million. So if the currencies
were allowed to float, the dollar would weaken. The cost of the
dollar would go down. Its 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
Peoples 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
they essentially make up for the difference
in demand for the dollar. Right here there's only
demand for $20 million. There's supply of 50. So what they do is they
create demand for $30 million. And the way that they create
demand for $30 million at that exchange rate is
that they can literally print, create 180. They could literally
create 180 million yuan. And then at an exchange
rate of six to one, that would essentially--
and they would go out there into the open markets and try
to convert this into dollars-- and so this would
create a demand for an incremental $30 million. And so when they do that,
the total demand for dollars is their $30 million
plus the $20 million 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're 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 dollar and how that's helping to
maintain a trade imbalance. This is Salman Khan of
the Khan Academy for CNBC.