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Studying for a test? Prepare with these 8 lessons on Money, banking and central banks.
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Video transcript
Let's review how China can maintain a trade imbalance with the United States by artificially keeping its currency weak. So we had a simplified scenario where we had an exchange rate of 6 Yuan per 1 Dollar. We had a Chinese manufacture selling 50 million dollars worth of microwaves in the United States. We had a US software producer selling 20 million dollars worth of software in China. If we had a floating exchange rate, the supply of dollars is much greater than the demand for Dollar. So that the Dollar will become weaker. It would be come weaker. And the Yuan would become stronger and that would resolve the trade imbalance. We saw that the People's Bank of China does not want that to happen. So what they do is they artificially create demand for Dollars to keep it strong They do that by essentially just printing Yuan and converting that it to Dollars. And that obviously also increases the supply of Yuan so it makes that less expensive. It weakens the Yuan and strengthens the Dollar. Now they're not going to just sit on literally cash with those dollar bills. They'll actually want to lend them out. So what this does is it increases the supply of money for loans. Supply of loans. When you increase the amount of Dollars that can be lent, that's going to lower the cost of borrowing Dollars. So the effect is you are lowering borrowing cost. And if you are lowering borrowing cost, that just means interest is less and it is easier to use your credit card either for the US government or if you are the US consumer. Now things- if that becomes cheaper, if that is cheaper or if you have a lower interest rate on your credit card that means that you are just going to consume more. So the end result- the big picture of what's happening here: In order to maintain a trade imbalance, in order to keep it's currency paid, you have the Chinese central bank essentially lend printing money, converting it to Dollars and then lending that to the US government and consumer. And what are they going to do with it? Essentially they are going to end up buying more Chinese goods. In our simplified example, they will buy even more microwaves.