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Current time:0:00Total duration:2:36

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. We had a Chinese manufacturer selling $50 million worth of microwaves in the United States. We had a US software producer selling $20 million worth of software in China. If we had a floating exchange rate, the supply of dollars is much greater than the demand for dollars. So the dollar would become weaker. It would become 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 it to dollars. And that obviously also increases the supply of yuan, so it makes that less expensive. It weakens the yuan, strengthens the dollar. Now, they're not just going to sit on literally cash with those dollar bills. They'll actually want to lend to them out. So what this does is it increases the supply of money for loans, supply of loans. Well, if 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 costs. And if you're lowering borrowing costs that just means interest is less, and it's easier to use your credit card, either if you're the US government or if you're the US consumer. Now, if debt becomes cheaper or we have lower interest rates-- If you have a lower interest rate on your credit card that means that you're 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 its currency peg, you have the Chinese Central Bank essentially 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're going to end up buying more Chinese goods. In our simplified example, they'll buy even more microwaves. This is Salman Khan of the Khan Academy for CNBC.