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Current time:0:00Total duration:12:10

Video transcript

let's review everything we've done in the last few videos and then take it a few steps from there so let's say we have a reality that right now and this isn't the actual exchange rate but I'm just using these numbers because they're nice simple numbers the current exchange rate is 10 10 1 / 1 US for one US dollar and now we're in a reality where the Chinese government and the Chinese central bank wants to keep this pegged so it wants to lock this it wants to lock this exchange rate right over here but the reality is more is being sold to the US more as being exported from China to the US than the other way around and so that leads to this weird dynamic that we've studied in the last few videos so this is China right here this is China and then you have the United States right over here United States and let's say at this exchange rate right over here you have you have let's say that you have Goods coming from China to the US actually let me do it in that same magenta color so these are Chinese goods so these are Chinese goods Chinese Chinese goods and then we are paying for those Chinese goods in dollars and those dollars are being sent to China and so we are paying so let's say we pay in this time period let's say it's a year let's say that there are hundred dollars one hundred one hundred dollars sent to sent to China for for the goods and this is really just a summary of what we saw in the last few videos and let's say on the other side of this equation some goods are sent from the u.s. to China some are exported so US US goods are exported to China and then we sell them in China and then we get someone in return that go back to the United States and of course reality the money seldom is actually sitting on a ship going across the Pacific it's all on these bank accounts that can be wired back and forth the actual exchanges are essentially happening Indian on the internet not really you know in any physical location but this is a good way to visualize it so the US goods are being sold in China and then the US producer is going to get one and let's say for their goods they get five hundred they get five hundred 500 won so if all of these people were to just convert and you actually don't know what the equilibrium price would be because the demand changes depending on what the price is in each of the countries but if you really wanted to convert these hundred dollars that the Chinese producer get into one at ten to one you would need you would need so we're gonna assume that this peg is what what at least the Chinese government wants so you would need so this guy needs let me put it here needs needs 1000 needs 1000 won in order to convert all of his hundred dollars at ten won per dollar now this producer the US producer only has only has let me do it in a different color only has only has and I should put the quotes around needs not around the wand now this US producer only has 500 500 won to convert to convert into dollars and we've seen this multiple puck times but I really want to reinforce it about how these currencies would fluctuate the demand for one is much higher than the supply for one and we could do the exact same argument with the dollar that the demand for dollars is much lower than the supply for dollars at this exchange rate if we assumed a peg this would only be 50 dollars that we need to convert into while there's a hundred dollars of actual supply but let's just focus on the one they need a thousand one if at this exchange rate there's only a thousand one that can be converted into dollars and if we had a floating exchange rate that would increase the demand for why and then this number would go down or another way to view it either that number goes down or this number over here goes up you could say it the wander to become more expensive which means maybe it's nine one per dollar or eight one per dollar or it could go the other way for ten wands instead of $1 you get a dollar ten or a dollar 20 or a dollar thirty either way now in order for this lock and for this peg to occur we saw in the last video that the Chinese central bank needs to intervene so the Chinese central bank the Chinese central bank remember where are the XS where are the XS dollars they're over here let me make it clear there's there's a hundred dollars over here there's a hundred dollars over here that need to be converted into one we have 501 over here we have the 501 501 that needs to be converted in to dollars now the Chinese government wants this hundred dollars to be converted into a thousand one so what he does or what they do is they say okay fifty dollars of this 50 dollars of this hundred dollars can be essentially traded for these 500 ones let me draw a two-way arrow there $50 $50 goes to the American producer and then the 501 the 501 go to the Chinese producer for four in exchange for that $50 obviously this isn't coordinated it's not like matchmaking it's not like someone said hey you give this money to them and but it essentially there will only be fifty dollars to convert into the one and then the other 50 dollars the other 50 dollars let me make it clear the other 50 dollars the other 50 dollars will go to the Chinese central bank will go to the Chinese central bank so let me draw the central bank Chinese Chinese central central bank and they will just print one and give another 500 one and they will just give another 500 one and this is exactly what happened in the last video I drew it a little bit all I'm showing is is to make up for the the lack of supply of one they needed a thousand one there's only 500 one to convert in order to make that up the Chinese central government prints the extra Chinese currency and buys dollars with it so it's essentially it's essentially sucking up it's sucking up the excess dollars right this was excess dollars right over here so that the dollar does not weaken it is it is sucking it is sucking up extra extra dollars so that the so that the supply for dollars isn't so high that it weakens or so that the Wan strengthens and so that's way the Chinese can maintain the trade imbalance they can continue to export more Goods than they are importing now what is the effect of this though and we saw this in order to maintain this currency peg while there is this trade imbalance the Chinese central bank keeps printing WAN and they keep accumulating dollars they keep accumulating dollars and if they ever stopped if they ever stopped accumulating dollar so it's not like they can just hold the dollars they have and the peg will hold if they ever stop accumulating dollars then the peg will break down they have to do this every time period they have to actively participate in the market printing wan and buying dollars they're doing it every day to maintain the peg not every day maybe sometimes when it won't fluctuate on their own but if the one is getting expensive to actually maintain a range they will buy dollars so they're just buying they're just accumulating more and more of these dollars and now this is where it gets interesting what does the Chinese central bank do with that cash now like anybody cashes useless you're not getting any interest on it it's just it's really it's just paper it allows you to buy other things that could give you some income or could give you some value so what the Chinese central bank does it doesn't hold actual dollar bills it goes and tries to buy the safest US denominated asset it can and another thing not only does it care about safety so it cares about so it wants to go to a safe asset it wants to go to a safe dollar-denominated asset dollar-denominated which means that you would buy it in dollars and if it produces interest the interest would be in dollars safe dollar denominated safe dollar denominated asset and it's also doing this on a massive massive scale on the hundreds of billions of dollars and actually the reserves and the trillions of dollars now so it's on a massive scale so they can't just go by a random company's stock one that won't be safe but also they would just drive the price up to infinity if they used they used this many dollars so it has to be a very liquid asset it has to be a very liquid asset a very liquid asset one that has a very deep market where the people trading in that market it really is in the tens and hundreds of billions of dollars and there's really only one asset that meets those requirements and that's US Treasuries u.s. US Treasuries and this isn't the only thing they will do but this is the great majority so what the Chinese central bank does with all of these excess dollars it essentially buys US Treasuries so it it gives the dollars away or not gives away it buys it sends the dollars to the people who are holding the US Treasuries and then it gets US Treasuries in return it gets US Treasuries US Treasuries now as a bit of review and I've done a few videos on this what are US Treasuries US Treasury bills and bonds are loans to the federal government so these are and that's maybe how you should view it these are loans to the federal government loans to federal government government these bonds these Treasury bonds are these Treasury bills that they're getting these certificates these certificates are essentially in fact they are io u--'s io u--'s from the USA not to get cheesy with the acronyms these are literally IOUs from the US government and the US government will pay interest they are essentially so just to make it all clear what's going what's going on they're printing money they're accumulating dollars they're buying those they're using those dollars to go out into either the open market or even directly from the Treasury from the US Treasury and they are buying US Treasuries which essentially means they are lending this money this is they are lending this money to the US government so they are lending to the US the US government now I'll leave you there in this video and maybe you want to think about a little bit before you even watch the next one but in the next one we'll talk a little bit about what that even means what happens if you have this big holder of US dollars this huge holder of US dollars going out there and buying Treasuries and being willing to lend money to the US government think about and in particular think about what would happen to interest rates and what those low interest rates impact would have on the rest of the US economy and on debt in general