Foreign exchange and trade
Current time:0:00Total duration:10:06
Currency effect on trade review
Let's review what happened in the last video because, in general, it's just kind of confusing and it's always good to see it a second time. And then we can think a little bit about how these market dynamics could be manipulated so that you don't have the Chinese currency getting more expensive. So the last video, we started off with an exchange rate of CNY 10 per dollar. We saw that this manufacturer over here in China had to sell his goods for the equivalent of CNY 10 in order for him to make a profit and that this guy in United States had to sell his goods abroad-- or we'll say in China-- for the equivalent of $1. Now it's this exchange rate, this price was $1 and at this exchange rate, this guy had to sell his cola for CNY 10 so that he could get his dollar. So we kind of just drew it out. And we said at that price, so for CNY 10 which was $1, at $1 there was demand for 100 dolls in the United States. So we saw this dynamic,. He would ship 100 dolls to the United States and then the United States would ship him back $100. He would sell those dolls for essentially $1 each, he would get back $100. On the other side of the equation, the cola manufacturer, if he were to sell it for CNY 10 in China, there's demand for 50 cans of soda. So he would send 50 cans of soda to China and they would send them CNY 10 for each can, CNY 500. Now, what happened in that situation is that the Chinese manufacturer had CNY 1,000 that he needs to convert into dollars, into $100 preferably, if that exchange rate were fixed. The American manufacturer, and let's say that these are the only two actors in our scenario, has CNY 500 that he needs to convert into $50. So if we just look over here, here's someone who wants to convert CNY 1,000. Or he wants to convert into CNY 1,000, let me be very careful. He wants to convert his $100 into CNY 1,000 if the currency were to be held constant. But there's only CNY 500 being offered in the market. So he was going to have to offer more dollars per Yuan then he would if there was more Yuan in the market. Now you can look at it from the other side. This American manufacturer has CNY 500 from his sales in China. He wants to convert it if the currency was pegged into $50, but maybe he could do better than $50 here. And as we can see, there's more demand to convert the Yuan than there is to convert the dollars. He wants to buy $50 using Yuan. This guy wants to sell $100 into Yuan. So if you look over here, the supply of dollars is much greater than the demand for dollars. And you know in anything, if the supply of apples is greater than the demand for apples, then the price of apples would go down. And the opposite is happening here with the Yuan. The demand for Yuan-- this is the demand-- is much greater then the supply of Yuan. And we know that when the demand is greater than the supply, the price needs to go up. And so we saw a scenario where the price of the dollar will go down in terms of Yuan. Now all that means is if you have to give CNY 10 per dollar, now you're going to have to give fewer Yuan per dollar. The price of Yuan would go down. If the price of apples in Yuan goes down, instead of offering CNY 10 per apple, you'd probably offer CNY 8 per apple. So we see the exact same thing for the price of the dollar. But that's equivalent to saying the price of a Yuan goes up. Now we said eventually, and I'm just making this number up, it's hard to predict what the actual settling price would be, we eventually get to CNY 8 per dollar. And then we said, at that exchange-- and actually I'm going to change the numbers a little bit just to make it a little bi cleaner-- at that exchange rate, at CNY 8 per dollar, these 10-Yuan dolls would now cost $1.25. And let's say that at $1.25, in the United States, there is a demand for 60 dolls. I'm changing the numbers a little bit from the last video just to make the numbers work out a little bit better. So you can just ignore the numbers from the last video. And remember, the older demand when the 10-Yuan dolls were only $1, so the old demand was 100 dolls. So it makes sense. If dolls are $1, people are going to have more of them. If dolls go up to $1.25, the demand will go down and say they'll go down to 60 dolls. Now on the other side of the equation, the $1 can of soda at CNY 8 per dollar will now sell in China for CNY 8. And remember what the old price was. The old price in China where the currency rate was 10 to 1 was CNY 10. So the price-- let me write it here-- the price the cola went from CNY 10 down to CNY 8. So the demand, now that the cola is cheaper in China, the demand went up. And I'll change this number too, so don't do the 80 cans. We'll say that the demand in China went from 50 cans, we saw that up here-- he had to ship 50 cans when it cost CNY 10 per can-- So it went from 50 cans up to-- maybe I make it go up-- the demand went from 50 up to, let's say, 75 cans. I'm using these numbers because it's going to lead to cleaner numbers. So now what is the actual scenario? In the last video I said work it out yourself, but I realize the more concrete examples of this, the more it will kind of sink into your brain. So now what is the trade balance going on? So going from China, and then you have the U.S. Over here we're going to be shipping 60 dolls. And then the U.S. is going to ship back 60 times $1.25, that is $75, right? $1.25 for 60 dolls means you're going to get $75. So $75 is going to go back to China. So that's due to the dolls, and now let's think about what's going to happen due to the soda. We are going to have 75 cans of soda are going to be shipped to China and then China is going to send back 75 cans at CNY 8 per can. 75 times 8, 600. So for the 75 cans, he is going to get back CNY 600. So now what's happening? The Chinese manufacturer over here on the left wants to convert $75 into-- if we assume that the currency is now eight, and he says, well, I'll just it get at the market rate-- into roughly CNY 600. 75 times 8 is 600. CNY 8 per dollar. And then the U.S. manufacturer wants to convert-- He's got CNY 600 from his sale of soda and, if he assumes he can get kind of the last market rate, 600 divided by 8 is into $75. So what just happened here? Now the supply of dollars is equal to the demand for dollars. And also, the supply of Yuan right over here is equal to the demand for Yuan. So now, depending on how you view it, we're sending the same dollar value to the U.S. as we're sending back to China, or we're sending the same Yuan value to the U.S. as we're sending back to China. And the currency is now in balance. It really shouldn't shift. So I really wanted to go through this example again to show you that when you have freely floating currencies, eventually one currency should get more-- if there is a trade imbalance-- expensive than the other until the demand equalizes in both countries so that you eventually do have a trade balance. Hopefully that doesn't confuse you too much, and in the next video, we'll talk about how a government-- and we'll talk about the Chinese Central Bank in particular-- could intervene so that this doesn't happen, so that they can always ship more to the U.S. than the U.S. ships to China.