If you have watched the currency videos by Khan Academy then you will gain nothing new from this post. This post is essentially a summary of what Khan discussed in those videos.
Lets assume that there are only two merchants in the market. A Chinese doll manufacturer who sells 1 doll per dollar and there is a demand for 100 dolls in US Market. Then there is a US Cola manufacturer who sells cola cans at also 1 dollar and there is a demand for 50 cola cans in China. Now lets assume that 10 yuan is equivalent to 1 dollar. Now, there will be 50 * 10 = 500 yuan in market but there will be 100 dollars to trade for it. Thus, the price of Yuan should increase.
But the Chinese central bank wants to keep Yuan devaluated. In this case, they will print more yuans and buy back dollars. Thus, they will get the excess 50 dollars for printing 500 Yuan. Now, they will exchange these 50 dollars for US Treasury bonds. Since, the Chinese central bank has a lot of US dollars, it will keep buying US Treasury bonds at low interest rates thereby making all debt in US cheap.
As the debt becomes cheap, US Government will spend more money and consumers will spend more. And these consumers will pay more for each other's services thereby increasing labor costs. And also they will buy more cheap chinese products. The cycle is hard to reverse. The Chinese government cannot stop printing money; because if it does so, the value of US treasury bonds will erode as the yuan goes higher against dollar. And while the US kept getting its manufacturing base depleted and having its whole economy financed with cheap debt; it will find it very hard to adjust to expensive debt will little or no manufacturing base. Thus, although both the parties are trying hard to reverse the situation, China needs to keep printing more money till a balance is achieved.
If you see the graph between Chinese Yuan and American dollar, you will see a very controlled currency by China here. They have been slowly inflating their currency as the Chinese Market has become more mature and started consuming more of the products they produce.
Lets assume that there are only two merchants in the market. A Chinese doll manufacturer who sells 1 doll per dollar and there is a demand for 100 dolls in US Market. Then there is a US Cola manufacturer who sells cola cans at also 1 dollar and there is a demand for 50 cola cans in China. Now lets assume that 10 yuan is equivalent to 1 dollar. Now, there will be 50 * 10 = 500 yuan in market but there will be 100 dollars to trade for it. Thus, the price of Yuan should increase.
But the Chinese central bank wants to keep Yuan devaluated. In this case, they will print more yuans and buy back dollars. Thus, they will get the excess 50 dollars for printing 500 Yuan. Now, they will exchange these 50 dollars for US Treasury bonds. Since, the Chinese central bank has a lot of US dollars, it will keep buying US Treasury bonds at low interest rates thereby making all debt in US cheap.
As the debt becomes cheap, US Government will spend more money and consumers will spend more. And these consumers will pay more for each other's services thereby increasing labor costs. And also they will buy more cheap chinese products. The cycle is hard to reverse. The Chinese government cannot stop printing money; because if it does so, the value of US treasury bonds will erode as the yuan goes higher against dollar. And while the US kept getting its manufacturing base depleted and having its whole economy financed with cheap debt; it will find it very hard to adjust to expensive debt will little or no manufacturing base. Thus, although both the parties are trying hard to reverse the situation, China needs to keep printing more money till a balance is achieved.
If you see the graph between Chinese Yuan and American dollar, you will see a very controlled currency by China here. They have been slowly inflating their currency as the Chinese Market has become more mature and started consuming more of the products they produce.
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