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Floating exchange effect on US

Floating Exchange Effect on US. Created by Sal Khan.

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Video transcript

Let's think about what might happen in the United States if the dollar is allowed to weaken relative to the yuan. So the most obvious thing is that Chinese imports will become more expensive. A less obvious effect is whether that will reduce the demand for Chinese imports, or whether that will have any impact on American inflation. The reason why that's not as clear is when you go buy your cell phone carrying case at your cell phone store, and you pay $30 for it, that $30 is not the cost that some Chinese manufacturer is getting for it. That Chinese manufacturer is probably charging on the order of $0.60, or maybe $0.80, or a dollar to produce that cell phone case. The rest of the money that you're paying is really going to the retailer, or to the suppliers, or it's there to essentially pay for shipping costs from China to the US. So this $0.60, which was how much it cost to make this in China, if this now goes up to $0.80, or if this goes up to $1.00 it's not clear that this price even has to change, or even if it were to change from $30 to $31 it's not clear that that would affect demand much. Now the impact that the weakening of the dollar would have on inflation is the idea that all imports would become more expensive. So all imports, potentially. And this depends how other countries react to the weakening dollar. But all imports could become more expensive. And probably the most important import, and once again, this depends on how these currencies react to some of the oil producing currencies-- oil producers actually peg to the dollar-- so it might not be as dramatic as you would think. But in general, if you have a weakening dollar, the most important, from an American point of view, the most important import of all, will probably on the margin become more expensive. And that is oil. We also potentially will have one less buyer going out there and motivating, or at least directly buying, or motivating other people to go buy US debt. So debt might become more expensive. So debt could become more expensive in the United States. And when I say debt becomes expensive that means that interest rates go up. And of course, this is hugely dependent on what the US Fed does. It could step in. It could continue to print more money and essentially keep the debt cheap. But it doesn't look as good optically. Now the last, and probably the most important question, and this is to some degree once again, not a clear cut answer, is what happens to US manufacturing? The argument has been to that essentially, China has been able to a produce cheaper than they would have even naturally been able to produce by keeping their currency devalued. That's allowed them to essentially steal an industrial base from the United States, to deplete the industrial base. Will this come back? Will some of this come back from China or other countries? And it is true, a weaker US currency will help the US exports. But what's less clear is whether industries that are labor dependent, and require maybe huge amounts of skill, whether those are going to come back from Asian. I suspect, like I said in the video on China, that those are either going to probably stay in Asia. Or if we had to think about where they might move if the Chinese currency got stronger, I would think that other parts of Asia, maybe South Asia, or maybe Latin America. If they can get their act together. Those are maybe more natural places to go, because they have the cheap labor. They have lower standards of living right now. And what they would need to do to compete with China in particular is essentially have the infrastructure, and the systems, and the efficiency, and the scale in place to compete effectively. So these are probably the people that China has to worry about the most if they devalue their currency, not so much the United States. Although will help US manufacturing on the margin to have a weaker currency. This a Salman Khan of the Khan Academy for CNBC.