Why Does China Manipulate its own Currency?

china is always one of the more controversial topics that we cover but as the world's second largest economy one that is home to a radically different market system than the us it is almost inevitable that this nation is just a great opportunity to see a lot of interesting economics in action in fact a lot of that controversy actually comes from the way this nation handles its economy and what these actions mean for the workers and consumers in the western world chief amongst these concerns is trade pretty much everything is made in china from low quality disposable toys to high-end electronics the nation has become the workshop of the world to the usa which rose to its prominent position today by also once been the workshop of the world this can seem very threatening this perceived threat true or otherwise has led to hostilities like the us-china trade war as well as a host of other tensions between china and other nations as it spreads its influence over the world now we are not here to speculate over china's plans for world domination but instead we are here to use this tension to explore something that has come up time and time again out of all of this and that is the idea that china is not playing fair in the game of global trade and that they are cheating other countries companies and consumers out of business by manipulating their own currency so how does a nation like china control their currency can this actually be used to give an unfair advantage in global trade if it can why doesn't every country do it can business profit off this middleman market failure and finally does currency price even matter at the end of the day someone could go to japan and be a millionaire because their currency has such a low denominated value but that doesn't really mean anything for global trade or our would-be baller this episode of economics explained was made possible by our fans on patreon if you would like to gain early access to these videos before they're uploaded to youtube as well as participate in our weekly exclusive q a sessions please consider supporting our channel on patreon.com economics explained now just the phrase currency manipulation has a sinister vibe to it it's almost never good to be called out for manipulating anything but is this more a case of bad branding or is this a genuine underhanded attempt to ruin their competition well perhaps the best way to actually assess this is to look at how a nation does control their currency and by extension how this impacts price competition in general most nations want to export lots of goods and services and import only what they really need to this relationship of imports versus exports is noted in a trade surplus if a nation exports more than they import or a trade deficit if they import more than they export you have no doubt heard the term trade surplus a lot because it's a pretty commonplace political football a trade deficit sounds bad and politicians will use this to scare people into thinking that their nation is losing the ability to make anything for themselves which can actually be somewhat true free trade is almost always a good thing for the overall wealth and prosperity of the nations engaging in that free trade but this prosperity can often come at the expense of local industry for example the uk used to have a very strong auto industry with a local branch of general motors operating in the nation under the name of vauxhall as well as the usual group of mini rover jaguar etc this industry employed tens of thousands of workers and they made just absolutely terrible cars now i know i know i can hear the rage in the comments already some of these cars were cool and today they are classics but the average consumer runabout that came out of these companies was absolute garbage it left a lot to be desired by their german and japanese and even their american rivals now they could get away with producing these lemons because the government was looking out for them if these international competitors wanted to sell a car in the uk they would be more than welcome to do so but they would have to pay import tariffs these are taxes levied on imports and they could be pretty steep a toyota corolla might have competed with a voxel astra on price in a perfectly fair market but if the japanese manufacturer had to pay a 30 import tariff then they would have to pass this expense on to their consumers making their car just simply too expensive for most households to consider over the domestic manufacturer this is part of the reason why if you watch old movies or tv shows having something like a honda was actually a pretty serious flex i holy jumping seizures catfish my h has been stolen now that's how people know it's a honda what's the point of having a honda if you can't show it on now these import tariffs were great for keeping the local business operating and by extension their employees employed but it was still a net loss overall the world is much better off today where everyone can buy a decent car for a decent price produced by businesses that have to compete and trade internationally as nations realize this barriers to trade like the aforementioned import tariffs have become less and less common however some nations are still looking to get a bit of an edge in less obvious ways chief amongst these techniques is lowering the value of their own currency artificially now a low-valued currency sounds kind of bad if you were to hear a news report saying that japanese yen lost three percent of its value overnight your first question might be oh no what is 2020 done to japan but in reality there are some big benefits to have a lower valued currency for starters if your currency is less valuable then importing stuff becomes more expensive now this sounds bad but let me explain if someone is tossing up between a cadillac and a mercedes they might be pretty cost comparable if the us dollar loses half of its value though then that mercedes is going to be twice as expensive to purchase because it is going to take double the amount of american dollars to pay the german auto manufacturer in euros this means that an american car buyer will just have to stick with the caddy and hey look american auto manufacturing lives to see another day this achieves the same thing as the tariffs we were looking at earlier but it does not break any rules of any trade agreements that will normally stipulate that tariffs are banned even better still the opposite effect is also true if a german was making that same decision then they would suddenly see that for the same portion of their euro savings they can now buy two cadillacs making it more tempting of a proposition than their locally offered mercedes now obviously any self-respecting german would not be caught dead driving a cadillac so this example is a bit oversimplified but it goes to show that devaluing a currency is a big win for local industry a question that a lot of switched-on people ask here is well wouldn't prices just adjust to reflect this i can go to japan and trade in 10 000 us dollars for 1 million japanese yen but that hardly makes me a millionaire right and that's correct 1 million yen probably has the same purchasing power as about 10 000 us dollars in reality probably less given the cost of living in japan versus the united states over a long enough time frame free-floating currencies will normally even out on purchasing power even if that means the nominal figures are different but and this is the important distinction here a nation like china is not deprising their currency they are devaluing their currency price and value are terms pretty strongly related to one another so if you're still confused think about it like this apple shares are about to be split into four what this means is that someone holding 10 apple shares on the 27th of august will wake up the next day with 40 apple shares sounds pretty good right the only problem is of course that these shares will now only be worth one quarter of what they were previously worth so our would-be investor hasn't really made any money off this split all other things been equal the benefit of this though is that apple shares are now easier to invest in because small-time traders can get in for 100 dollars rather than the 400 per share apple is currently trading at but all the same one apple share versus four quarters of an apple share 10 000 us dollars versus 1 million yen these pairs all have the same value one apple share today will pay the same dividends as four apple shares next week and i can buy the same gaming pc for 10 000 us dollars as i might be able to with one million japanese yen what china is doing with its currency is not like what apple is doing with its shares it's more like apple trying to push its share price down 50 percent without changing anything else now apple would never want to do this of course because it is owned by shareholders who want to see healthy returns on those shares but for all of the reasons that we saw earlier a sovereign nation like china may want to do this with its currency so the only other question is how is this even possible economists will talk at length about the guiding hand of the market how it's impossible to fight the market and win and how everything else eventually moves towards equilibrium so how is it that china is apparently fighting this unstoppable force to push its own currency down well it's actually pretty ingenious they use the market forces to their advantage by effectively becoming the market in the regular foreign exchange market there are hundreds of thousands of entities buying and selling and trading at currencies this can be anybody from some schmuck at the airport cash exchange trying to get some spending money for their holiday all the way up to goldman sachs exchanging billions of us dollars for euros but the market for chinese currency is a little bit different the chinese government says that this is the price and that is what it is for argument's sake let's say it's five rmb for every one us dollar to make this happen the government will set up their own exchange where everybody and anybody can come in and trade five rmb for one u.s dollar or one us dollar for five rmb so long as they can keep on facilitating this trade then this is what the price will be to understand why consider this let's say you are planning a trip to shanghai and you need to exchange some american dollars to r b to pay for everything while you're over there if someone offered you four rmb for every one us dollar you would tell them to get stuffed because you can just go to the government exchange and get five rmb for your dollar the opposite is also true nobody is going to be willing to give you six rmb for every one dollar because they would be better off going to the government exchange where they only need to pay five rmb for every us dollar so long as that exchange is functioning to determine both buy and sell prices of r b that price is not changing now one big drawback of this system is that the government will need to maintain this exchange and keep a lot of foreign currency on hand if someone wants to trade 2 billion rmb for 400 million american dollars they are going to need 400 million american dollars now collecting and keeping that much cash is expensive remember they are not just controlling their currency against freedom dollars either so they need to keep euros and pounds and yen and all of this actually cost the chinese government a lot of money fortunately though they no longer need to service a majority of this trade because people have learnt to accept that five rmb is one us dollar then they will just trade amongst themselves for that price to make everything easier always knowing in the back of their mind if that price deviates at all they can always go back to the government exchange curiously enough the expense involved in managing this exchange is very similar to the net cost borne by society through the tariffs that we saw earlier now this gets extremely technical but an import tariff creates what is called a deadweight loss on society go watch our video on black market economics to learn more about that but in short it is basically just the cost of market inefficiencies now to achieve the same trade advantage the cost borne by managing an exchange would be equal to the deadweight lost experienced through a trade tariff the only difference is that the exchange is paid for by the government directly with tax dollars and a deadweight loss is paid indirectly by taxpayers with higher prices i will leave a journal article in the sources and citations listing that goes over this in much more detail for the uber nerds amongst you that are interested in that but otherwise the takeaway is this messing with a free market is gonna cost you sure you can prop up local industry and maybe the benefits of that will outweigh the costs in the short term but either way if you want to mess with mr market expect a slap on the bottom line now for the entrepreneurial amongst you maybe you heard the phrase market inefficiencies and a light bulb is going off that hey market inefficiencies mean that there is profit to be made by taking advantage of these inefficiencies so how would one do that here well your us dollars are technically overvalued in china so you take them over there and use that money to buy anything it could be a car or a piece of furniture or a phone whatever it doesn't matter what does matter is that you are going to be able to get more stuff for your us dollars than you would have otherwise been able to in america now once you have secured your goods you bring them back to the united states to sell them for a price without the influence of the undervalued foreign exchanger oh wait a second this is just importing stuff from china to sell congratulations you've made a profit but you are playing the game that china wanted you to play all along currency international trade market intervention chinese business practices and foreign exchange are by their nature all very complicated issues if you throw all of these factors into a blender together you get the controversy around currency manipulation most people don't understand it but everyone seems to be afraid of it so is this something to really be angry about well yeah sure but only as angry as you would be about a trade tariff which i'm going to go ahead and assume for most of you is not ferry what's more is that every day china is loosening this grip on its currency today rmb is influenced by market forces and only occasionally beat back in line with expectations realistically in the not too distant future it's likely to become a fully free-floating currency which will position the rmb to become more widespread and universally accepted perhaps one day it would even rival the us dollar but more about that in our next video in this series until then i hope you enjoyed this one if you did please consider liking and subscribing this video was another great suggestion by one of our patrons over on patreon so if you want to have your say about what country or topic we explore next please consider supporting the channel like these awesome people did thanks guys bye

Channel: Economics Explained

Views: 291,670

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Keywords: how to win trade and influence prices, how to win trade wars, how does china manipulate its currency, why does china manipulate its own currency, china currency devaluation explained, why does china devalue its currency, how does china devalue its currency, currency manipulation, china currency, us china trade war, china currency manipulation, currency war, china currency vs us dollar, china currency crisis, the economics of china, china economics explained, economics explained

Id: ezY33u8V8V8

Length: 15min 31sec (931 seconds)

Published: Thu Aug 27 2020