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China keeps peg but diversifies holdings

China keeps peg but diversifies holdings. Created by Sal Khan.

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Video transcript

We know the US is running a relatively large trade deficit relative to China in 2009. We imported $260 billion more than we exported to China. And we know from the last few videos that the way that China is keeping their currency from appreciating because of this trade imbalance is that they're going out there, printing money, and using that yuan to buy dollar assets. And we see over here in 2006, 2007, 2008, major increases in US assets. But what's a little bit more interesting is that, in 2009, we didn't have a huge increase. It's pretty large by any standard, but not large enough to offset the actual trade imbalance. So how did China keep its currency peg? Even better, let's actually look at-- because this isn't just the Chinese government. These are just ownership of US assets by Chinese nationals. But we can actually look at the major foreign holders of treasury securities. This actually comes from the Treasury's own website. And it tells us how much different central banks, how many the treasury securities they are actually holding. And you can see China is the biggest holder. If you go to November of 2009, it has $929 billion. This is the People's Bank of China. It has $929 billion worth of US treasuries. But what's interesting here, it is the largest holder, but as we go from November of 2009 to November of 2010 their holdings actually went down. Not by a ton. They're still right around $900 billion. But they went down. So given the fact that we have this trade deficit, given the fact that they want to peg their currency, and that they want to print money, and go buy other people's assets, how did this happen? How did the number of treasuries actually go down? And actually how were they able to reduce the amount of all US assets that they bought? Now, the treasury answer is they don't have to just buy treasuries. They could by other US assets, but even over here we saw that they didn't buy a ton of other US assets. And a clue to what's happening here, and this isn't exactly what's necessarily happening, it's far more complicated than I could explain in one video, is that we do see other countries whose US Treasury holdings are increasing dramatically over the course of 2010. In particular, you see the United Kingdom. Their holdings have grown from $155 billion to $500 billion over the course of 2010. And this is relative. The United Kingdom does not have a significant trade imbalance one way or the other with the United States. And we actually see we actually see that it's currency really didn't change much over the course of 2010. It's been about the same. And this looks more dramatic than it really is. So the answer, and it could be much more complicated than this, is that China has decided to somewhat diversify from buying US treasuries, and in particular US assets. And maybe they're diversifying to the pound sterling, maybe they're diversifying to the Euro. And so they will start buying, say, British assets. But the British don't want their currency to appreciate too much because then they'll suffer trade consequences. Their goods will be too expensive. And so the British Central Bank would then want to maybe, so that their currency does not appreciate relative to the dollar, they'll want to go and buy American assets. And that's what it looks like is actually happening. And maybe one other small point is that the Chinese government has slowly allowed its currency to appreciate. But the appreciation isn't as dramatic as this chart makes it look. This is 6.8 yuan to the dollar at the beginning of 2010 to about 6.6. And we're not getting close to 0 here. This is just from 6.8 to 6.6. But over the last several years they have slowly been allowing their currency to appreciate. But what's really happening is that they're diversifying away from dollar assets. But when they buy those other currencies those people are going to want to buy dollar assets to keep their currency from moving too much.