Let’s review how China can
maintain a trade imbalance with the United
States by artificially keeping its currency weak. So we had a simplified
scenario where we had an exchange
rate of 6 yuan per $1. We had a Chinese manufacturer
selling $50 million worth of microwaves
in the United States. We had a US software
producer selling $20 million worth of software in China. If we had a floating exchange
rate, the supply of dollars is much greater than
the demand for dollars. So the dollar would
become weaker. It would become weaker, and
the yuan would become stronger. And that would resolve
the trade imbalance We saw that the
People’s Bank of China does not want that to happen. So what they do is they
artificially create demand for dollars
to keep it strong. They do that by essentially just
printing yuan and converting it to dollars. And that obviously also
increases the supply of yuan, so it makes that less expensive. It weakens the yuan,
strengthens the dollar. Now, they’re not
just going to sit on literally cash with
those dollar bills. They’ll actually want
to lend to them out. So what this does is it
increases the supply of money for loans, supply of loans. Well, if you increase the amount
of dollars that can be lent, that’s going to lower the
cost of borrowing dollars. So the effect is you are
lowering borrowing costs. And if you’re lowering
borrowing costs that just means interest is less, and it’s
easier to use your credit card, either if you’re
the US government or if you’re the US consumer. Now, if debt becomes cheaper or
we have lower interest rates– If you have a lower interest
rate on your credit card that means that you’re
just going to consume more. So the end result,
the big picture of what’s happening here,
in order to maintain a trade imbalance, in order
to keep its currency peg, you have the Chinese
Central Bank essentially printing money,
converting it to dollars, and then lending that to the
US government and consumer, and what are they
going to do with it? Essentially, they’re
going to end up buying more Chinese goods. In our simplified
example, they’ll buy even more microwaves. This is Salman Khan of
the Khan Academy for CNBC.