-
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
yuan per U.S. $1.
-
And now we're in a reality where
the Chinese Government,
-
the Chinese Central Bank,
wants to keep this
-
[? PEG'd, ?]
-
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 U.S., more
-
is being exported from China
to the U.S. 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, and
then you have the United
-
States right over here.
-
And let's say at this exchange
rate right over here, you have
-
goods coming from China to the
U.S. Actually, let me do it in
-
that same magenta color.
-
So these are Chinese goods,
and then we are paying for
-
those Chinese goods in dollars
and those dollars are being
-
sent to China.
-
So let's say we pay in
this time period.
-
Let's say it's a year.
-
Let's say that $100 sent to
China 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 U.S. goods
are exported to China,
-
and then we sell them in China
and then we get some yuan in
-
return that go back to
the United States.
-
And, of course, the reality is
that the money seldom is
-
actually sitting on a ship
going across the Pacific.
-
It's all in these bank accounts
that can be wired
-
back and forth.
-
The actual exchanges are
essentially happening on the
-
internet, not really in any
physical location, but this is
-
a good way to visualize it.
-
So the U.S. goods are being
sold in China and then the
-
U.S. producer is going
to get yuan.
-
And let's say for their goods,
they get 500 yuan.
-
So if all of these people were
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 $100 that the
Chinese producer gets into
-
yuan at 10:1, you would need--
so we're going to assume that
-
this PEG is what at least the
Chinese Government wants.
-
So you would need 1,000 yuan in
order to convert all of his
-
$100 at 10 yuan per dollar.
-
Now this producer, the U.S.
producer, only has-- let me do
-
it in a different color and I
should put the quotes around
-
needs, not around the yuan.
-
Now this U.S. producer only has
500 yuan to convert into
-
dollars, and we've seen
this multiple times.
-
But I really want to reinforce
it about how these currencies
-
would fluctuate.
-
The demand for yuan is much
higher than supply for yuan.
-
And we could do the exact same
argument for 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 that we need to convert
into, while there's $100 of
-
actual supply.
-
But let's just focus
on the yuan.
-
They need 1,000 yuan at
this exchange rate.
-
There's only 1,000 yuan that can
be converted into dollars.
-
And if we had a floating
exchange rate, that would
-
increase the demand for yuan,
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 the yuan would
become more expensive, which
-
means maybe it's 9 yuan per
dollar or 8 yuan per dollar,
-
or it could go the other way.
-
For 10 yuan, instead of $1,
you'd get $1.10 or $1.20 or
-
$1.30, 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.
-
Remember, where are the
excess dollars?
-
They're over here.
-
Let me make it clear.
-
There's $100 over here
that need to be
-
converted into yuan.
-
We have 500 yuan over here that
needs to be converted
-
into dollars.
-
Now, the Chinese government
wants this $100 to be
-
converted into 1,000 yuan.
-
So what he does or what they
do is they say, OK, $50 of
-
this $100 dollars can be
essentially traded
-
for these 500 yuan.
-
Let me draw a two-way arrow
there. $50 goes to the
-
American producer and then the
500 yuan go to the Chinese
-
producer 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.
-
But essentially, there will only
be $50 to convert into
-
the yuan and then the other
$50 will go to the Chinese
-
Central Bank.
-
Let me draw the Chinese Central
Bank, and they will
-
just print yuan and give
another 500 yuan.
-
And this is exactly what
happened in the last video.
-
I drew it a little
bit different.
-
All I'm showing is to make up
for the lack of supply of
-
yuan, they needed 1,000
yuan, there's
-
only 500 yuan 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 sucking up
the excess dollars, right?
-
This was excess dollars right
over here so that the dollar
-
does not weaken.
-
It is sucking up extra dollars
so that the supply for dollars
-
isn't so high that it weakens
or so that the yuan
-
strengthens.
-
And so that's the way
the Chinese can
-
maintain the trade imbalance.
-
They could 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 yuan and they keep
accumulating dollars.
-
And if they ever stop
accumulating dollars, 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 yuan and
buying dollars.
-
They are doing it every day
to maintain the PEG.
-
Not every day, maybe sometimes
when it won't fluctuate on
-
their own, but if the yuan is
getting expensive, they
-
actually maintain a range, and
they will buy dollars.
-
So 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,
cash is useless.
-
You're not getting any
interest on it.
-
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 U.S.-
-
denominated asset it can.
-
And another thing, not only does
it care about safety-- so
-
it wants to go to
a safe asset.
-
It wants to go to the safe
dollar-denominated asset,
-
which means that you would buy
it in dollars, and if it
-
produces interest, the interest
would be in dollars.
-
And it's also doing this on a
massive, massive scale, in the
-
hundreds of billions of dollars,
and actually the
-
Reserve is in the trillions
of dollars, so it's
-
on a massive scale.
-
So they can't just go buy 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 this many dollars.
-
So it has to be 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
U.S. 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 U.S. Treasuries.
-
So it gives the dollars away.
-
Well, not gives away, it sends
the dollars to the people who
-
are holding the U.S. Treasuries,
and then it gets
-
U.S. Treasuries in return.
-
Now, as a bit of review, and
I've done a few videos on
-
this, what are U.S.
Treasuries?
-
U.S. Treasury bills and bonds
are loans to the Federal
-
Government.
-
So that's maybe how you
should view it.
-
These are loans to the
Federal Government.
-
These bonds, these Treasury
bonds or these treasury bills
-
that they're getting, these
certificates, are
-
essentially-- in fact, they
are-- IOUs from the U.S.A, not
-
to get cheesy with the acronyms.
These are literally
-
IOUs from the U.S. Government,
and the U.S. Government will
-
pay interest. They are
essentially-- so just to make
-
it all clear of what's going
on, they're printing money.
-
They're accumulating dollars.
-
They're using those dollars to
go out into either the open
-
market or even directly from
the Treasury, from the U.S.
-
Treasury, and they are buying
U.S. Treasuries, which
-
essentially means that they are
lending this money to the
-
U.S. Government.
-
Now, I'll leave you there in
this video, and maybe you want
-
to think about it 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 U.S. dollars,
-
this huge holder of U.S. dollars
going out there and
-
buying Treasuries and being
willing to lend money to the
-
U.S. Government?
-
Think about it.
-
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 U.S. economy
-
and on debt in general.