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Current time:0:00Total duration:14:20

Video transcript

what I want to do in this video is explore how trade imbalances in theory should be resolved by freely floating currencies so let's just say at the beginning of our time period like we did in the last video that the exchange rate between the Chinese won and the US dollar is 10 to 1 so we have 10 won so the last time people traded these currencies they exchanged 10 won for one US dollar so one one and when I say dollar I'm going to implicitly mean the US dollar now let's think about 2 entrepreneurs in each of the countries or one in each of the country so let's talk about a Chinese entrepreneur so we are in China here and he makes dolls he makes dolls let me draw one of the dolls and in order to profitably sell a doll he needs to sell them for 10 won so sell so needs needs to sell for 10 won if he's able to sell for the equivalent of 10 won in the United States and we won't talk a lot about shipping and what currency you would have to paint in all of that then he can pay all of his needs maybe even the the shippers across the Pacific maybe their employees are also Chinese so they want their money in wan and obviously most of the cost would be for manufacturing this doll and all of his employees want to be paid in wan his own rent for the factory or even his own rent for his own house it all has to be paid in one so this is what he needs to sell his doll for 10:1 and at the current exchange rate that would be one u.s. dollar now let's go across the Pacific let's go across the Pacific let's go to the United States and let's say that we have another entrepreneur who's making soda are making Cola for export so let me draw a can of cola cola and similar to this guy in China he needs to sell his product abroad for the equivalent of a dollar so that it can cover shipping costs and manufacturing costs and the high fructose corn syrup and all of that so needs needs to sell for for one US dollar and once again he cares about dollars because he has to pay his own mortgage in dollars his employees need to be paid in dollars maybe the shippers he used they only accept dollars so this is how both of these characters think about it now at the current exchange rate so at this current exchange rate let's say that the demand for these dolls that there is demand for $100 in China or sorry at the current exchange rate there is demand for $100 in the United States this guy is exporting and so is this guy well make it a very simple they're only focused on export so at at current exchange at current current exchange I'll do it for both there is for the doll guy there is demand there's demand for demand for 100 100 100 dolls in the United States so what does that mean that means that if you if he can sell these dolls for $1 which is equivalent to 10:1 then there's going to be a hundred people in some time period let's say it's a year or a month who are going to be willing to buy the dolls at that price and let's say also at this current exchange rate in China in China 50 people are willing to buy this Cola so the current exchange rate demand demand for 50 50 cans demand for 50 cans in China obviously these are ridiculously no numbers but we're just dealing with simple numbers to help our thinking and let me write the add current exchange rate as well at current exchange rate current exchange rate so what we're saying is that in China he needs to get a dollar at the exchange rate that's 10:1 so if he were to in a store in China or to a distributor in China maybe sell each of these cans for 10:1 there's demand for 50 cans in China now what's going to happen here I think some of y'all might already see that a trade imbalance is developing so what's going to happen here so this guy he likes doing this and this guy likes doing it so what's going to happen in this time period this Chinese guy is going to ship over he is going to ship over 100 dollars so he's going to ship over 100 dolls to the United States so let me write this down this is China this is the US over here and what's the u.s. going to do well the u.s. is going to ship over the u.s. is going to ship over essentially he remember he's selling this in the United States so each 10-1 is $1 so for each doll he's going to get $1 so he's going to get back $100 he is going to get back 100 US dollars for his dolls and then and then once he gets back 100 US dollars for his dolls he's going to want to convert them into one so then he will try try to convert the 100 100 dollars into into one so this is what will end up happening for this guy let's say these are the only two people trading between China and the United States just to really simplify things now let's think about what happens on the right side over here this guy is going to ship 50 Cola cans to China so we have cola can right over there Cola he is going to ship 50 of them to China from the United States and what is he going to get back in return well they're going to it's being sold to Chinese distributors so they're going to pay him in one so for each can at the current exchange rate or the at the cat in the cart price he's going to get 10:1 so when you when you convert it back when you convert it or he's going to get 10:1 per can so 10:1 times 50 is 501 500 501 is what he's going to get and then he's going to try to convert try to convert let me write that in a different color just to just really for the sake of it so he's going to try to try to convert because he has to pay his expenses in dollars he is his 501 into into now what's the exchange rate that he wants to his goal is in to to cover his cost he has to get 10 to 1 so 500 1 into $50 into 50 into $50 let me make it clear this guy thinks he's going to get 10 1 for every dollar so he wants to convert his hundred dollars into 1,000 won so let me write it here 1,000 I should have written it over here but let me write 1,000 1 over here so what just set up if these are the only people trading goods and currency in this time period when we just set up well clearly this guy is shipping more value to the US then this guy is shipping to China there is a trade imbalance if you think of it in terms of dollars this guy is shipping $100 worth of goods to the US this guy is only shipping $50 worth of goods to China so there's a net trade imbalance of $50 China's shipping $50 more the US and the other way around if you think about it in 1 it would be a trade imbalance of 500 won and because of that because of that this guy is trying to convert many more dollars into one then this guy is trying to convert the other way around notice there is more demand more demand more demand for 1 then dollars what's going to happen especially if these are the only two people trading if these are the only two people trading this guy is going to say hey you know I've got I've got 10:1 let me convert it in two dollars it'll be just like what we saw in the last video and obviously there will be more actors here but whenever you this guy is more this guy has more stuff to convert than this guy in fact if these were the only two people trading he wouldn't even be able to convert all of his currency into into one because there's only 501 available on the market this guy thinks he should get a thousand won and obviously if the price of the wand goes up like we see in the previous video maybe there'll be more people who want to convert one or maybe fewer people who'd want to convert dollars so we can you can think about all of those but I really want to think about how this will this will potentially resolve the trade imbalance so we see we have a situation more demand on more demand for Wanda dollars there's a demand for thousand won here there's only 501 being sold or you could view it the other way there's only demand for $50.00 there's only demand for $50.00 and there's $100 being sold either way there's an imbalance so what's going to happen well you're going to have you're going to have either depending on how you want to view it you could have you could say that the price of the dollar of the dollar will go down or you could say that the price of the one will go up and the dynamics would be like we saw in the last video this guy over here would sell a couple of his wan and they say wow there's really there's this guy over there who really wants to buy it and then maybe he'll keep saying well you know what instead of instead of instead of giving me instead of giving me a dollar for every ten of Maiwand why don't you give me a dollar for every nine of Maiwand or eventually why don't you give me a dollar for every eight of Maiwand and so he'll keep raising the price of the one he'll he'll keep he'll keep giving fewer and fewer wands for each of the dollar and let's say this goes on for a little bit and I really want to explore the trade amounts let's say at some point and obviously maybe more and more people come into the market so eventually it clears because right now there isn't enough wand for this guy but as you can see the price of the wand goes up so after all of this because of this trade imbalance because more people want to convert dollars into one than one into dollars the currency changes so you could imagine and I'm just going to make up some numbers here that the one becomes more expensive it was 10:1 to the dollar now maybe it is eight eight one eight one two dollar eight one $2.00 so this is where we get to eventually get to eventually because of this supply-demand imbalance right over eight one $2.00 now what's the reality over here this guy over here this guy over here he needs to sell his dolls for 10:1 which before was the equivalent of one dollar but now how much is he going to sell his wand for how he needs to sell for 10:1 that's eight one per dollar right so let's let's think about how much his dolls cost so his dolls in the US now that the wand has appreciated they were ten one ten one and then times we have one dollar one dollar for every eight for every eight one so this is going to be equal to the wands cancel out this is really just dimensional analysis you might have learned in chemistry so 10 over eight is what that's one and one-fourth this is a dollar twenty-five so this is one point two five dollars notice the price of his dolls went up in the United States in terms of dollars and let's think about what happened to the cola manufacturer the cola manufacturer right over here cola so his cost or hit the pricing needs to sell them for our one dollar one dollar and now what's the exchange rate one dollar let me write it the other way because I need to cancel out the dollars we have eight one eight one for every one dollar for every one dollar dollars cancel out eight times one he'll now his selling price and the unita will now be eight one will now be eight one so notice neither of these people changed their prices in terms of their home currency no change in price at all but because of the currency movements because the wand became more expensive this guy's goods the Chinese manufacturers goods are now more expensive in dollars and the American manufacturers goods are now less expensive in one so what's going to happen what's going to happen here at a dollar there was a demand for a hundred dollars in the United States but now that the price has gone up now that the price has gone up to a dollar twenty-five now there will only be demand demand now there will only be demand let's say they're now at this higher price now there's only demand for $50 $50 in the United States and let's say this guy over here before there was demand for 50 cans of his Cola in China because it was ten ones but now the price has gone down so let now you can imagine that there is demand or actually I should say there's demand for 50 dolls not 50 there's demand for $50 and now because this guy's price has gone down now instead of demand for 50 cans maybe there's demand for and I'll just make up a number 80 cans maybe there is now demand for 80 cans so what just happened to the trade imbalance before in terms of either currency we were buying more dolls and if you think about it from the US perspective and shipping fewer Cola but now that has note that that we're buying fewer dolls because it's now more expensive the United States and we're shipping more Cola so I don't even know how this math works I don't know let you figure that out but as one currency gets more and more expensive those exports the demand for those exports from those countries are going to go down like we saw with these dolls and on the other side as the other currency gets cheaper and cheaper and cheaper the demand for those exports will go up because in other currencies it will look cheaper and eventually you should have some type of trade balance