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Floating exchange resolving trade imbalance

Floating Exchange Resolving Trade Imbalance. Created by Sal Khan.

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  • old spice man green style avatar for user pardijoe
    If you are following the "Current Economics" playlist and this video confused you, watch the first couple of videos in the "Currency" playlist (Currency exchange introduction, Currency effect on trade, etc). I just did and it makes sense now.
    (20 votes)
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  • leaf green style avatar for user Tarek Seif El Nasr
    Why is the supply of dollar larger?
    (3 votes)
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  • starky ultimate style avatar for user mtboy66
    C.N.B.C.?
    (4 votes)
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  • leaf green style avatar for user FinallyGoodAtMath
    Is Chinese currency called "yuan" or "renminbi"?
    (5 votes)
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    • aqualine seed style avatar for user Martin N
      Well, I can speak Mandarin Chinese and according to my knowledge Yuan (元)and RenMinBi (人民币 - lit. "the people's currency / the people's coins") both are correct. It's even possible to say 人民币元 (renminbiyuan), but it's very very formal.

      And by the way, in everyday life, when people talk about how much something costs, they don't even use any of these words. They just use "kuai" (块) which is one unit of RMB.
      (3 votes)
  • leaf yellow style avatar for user James Jamey
    If the American exporter can make more money on a weaker dollar why would he lower his prices?
    (1 vote)
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    • ohnoes default style avatar for user Tejas
      The American exporter isn't lowering his prices. The cost of American exports will remain the same, in terms of dollars. The difference is that Chinese consumers will simply need to pay fewer Yuan to get the needed dollars, so the price will only decrease in terms of Yuan.
      (4 votes)
  • leaf green style avatar for user Zaphod Beeblebrox
    So does this mean that when US buys stuff from China they pay in USD? And when China buys stuff from US they pay in renmibi/yuan?
    (2 votes)
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  • blobby green style avatar for user James Fishtins
    I couldn't understand the logic in the middle of the video when the supply and the demand of the dollar became imbalanced.
    Any clarifications?
    (1 vote)
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    • duskpin ultimate style avatar for user tuannb1997
      The Chinese manufacturers collect $50M in Revenue and want to convert the money into Yuan so as to spend it in China, therefore they are willing to trade the U.S dollar they're holding with someone who is looking for U.S dollar - in this case, U.S manufacturers of software products exported to China. However, the U.S producers collect only 120M Yuan, equivalent to $20M. In this ultra-simplified world, sellers of dollars supply $50M, while buyers of dollars demand $20M, leading to a surplus of $30M. The price of dollar, relative to Yuan, would therefore go down as a result.
      (2 votes)
  • ohnoes default style avatar for user a.m.ahkee
    How does more chinese importers buying US goods affect the dollar exchange rate and fiscal policies in the US?
    (1 vote)
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  • leaf green style avatar for user Kagan D.
    At Sal said that "And eventually, you would have this trade and currency imbalance resolve itself. Now, this is all theoretical and the reality is that it's not allowed to float". As far as I know, most countries in the world don't intervene in the currency exchange rate and at the same time they have positive/ negative "balance of payment". My question is, what's prevents the "balance of payment" of these countries from changing to zero by adjustment of the currency exchange rate and how they're able to keep positive/ negative "balance of payment" for long periods of time?
    (1 vote)
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    • piceratops ultimate style avatar for user jecrapse
      Less than 10 currencies are freely traded. The rest are either pegged to the dollar, another currency, a basket of currencies, or mandated in some other manner as a dirty float ( limits movement in a pegged range) by their CB
      (1 vote)
  • blobby green style avatar for user Mai
    I don't understand this sentence, "The supply of dollar is larger than the demand for dollar in this situation." @ .

    How is it related to supply since it isn't about printing?
    (1 vote)
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Video transcript

What I want to do in this video is explore how the floating exchange rate could, in theory, help resolve trading imbalances. And for this simplified example, We are going to assume that the exchange rate between the Chinese Yuan and the US $ is 6 Yuan per 1 US $. And also for simplification, we are going to assume that China is only exporting one thing to the United States and that one thing is microwaves. And at 6 yuan per $, the Chinese manufacturer is going to sell them in the United States for $50 each. And at that price, there is a demand in the US for 1 million microwaves. I'm also going to assume that the only export from the US to China is software. And they have demand for 2 million units if they sell them at 60 yuan per unit. So let's think about what the demand for the each of the currencies will be from each of the manufacturers. So the Chinese manufacturer over a year is going to sell a million units for $50 each. So he's gonna get $50 million dollars in revenue And he is going to want to convert that $50 million into yuan. So you can kind of view this as a supply. This right over here is the supply of US dollars. And we are going to assume that these are the only people that are creating currencies, because they are the only people trading in this ultra simplified world. Now the US manufacturer is going to sell 2 million units at 60 yuan each. So that's going to be 120 million yuan of revenue. And he is going to want to convert this into dollars at the prevailing exchange rate right then which is 6 yuan per dollar. So he's going to want to convert this. He divides this by 6. He's going to want to convert that into 20 million dollars. And obviously, he's going to want to convert into yuan, because that's where his costs are in, that's where he lives. This guy wants to convert into dollars, because that's where his costs are. Now this is the supply of dollars. These dollars wants to be converted into Chinese currency. This right here is the demand for dollars. This is the amount of $ needed by a guy converting from yuan. Now clearly, there is an imbalance. The supply of $ is much larger than the demand for $ in this situation. And anytime the supply for anything is larger than the demand... If the supply is larger than the demand then that means the price must go down. And we talk about the price of a currency, in this case, the price of the dollar going down. We are talking about in terms of yuan. So the dollar... ...the dollar will go down. The price goes down which means the yuan goes up. The dollar will become weaker. The yuan will become stronger. Now, if that happens, what happens to the prices over here? If the yuan becomes stronger, we start seeing 4 yuan or 5 yuan per $ or even 3 yuan per $. Then this Chinese manufacturer won't be able to afford to sell at only $50. He is going to have to raise the price in order to cover his costs in Chinese currency. If he raises the price, he's going to lower the demand. On the other side of the equation, the American manufacturer, in order to get the same number of dollars, he actually can sell it for fewer yuan. Now he needs fewer yuan per each dollar. So he can actually lower the price in China. And if he lowers the price in China, that's going to increase the demand. So what you have happening is because yuan would become stronger, if you had a floating exchange rate, the demand for Chinese goods would go down and the demand for the US goods would go up. And eventually, you would have this trade and currency imbalance resolve itself. Now, this is all theoretical, and reality is that it's not allowed to float. We'll describe that more in future videos. This is Salman Khan from the Khan Academy for CNBC.