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## Foreign exchange and trade

Current time:0:00Total duration:10:06

# Currency effect on trade review

## Video transcript

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.