value quantity yuan u.s. $ d – u.s. imports from china (china exports) s – china imports from...
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valuevalue
quantityquantity
Yuan U.S. $
D – U.S. imports fromChina (China exports)
S –China imports from U.S. (U.S. exports) S –U.S. imports
from China (China exports)
E1
EE2
D China imports from U.S. (U.S. exports)
E
E1
E2
1.) China imports from U.S. : Chinese businessmen must pay for goods with U.S. $. They sell Yuan and buy $ . Creates supply of Yuan that will be used by U.S. importers.
2.) U.S. imports from China : U.S. businessmen must pay for goods with Yuan.They sell U.S. $ and buy Yuan. 3.) Since the U.S. imports more from China than China imports from U.S., the shifts in blue are greater than the shifts in red.
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Effects on currencies resulting from trade deficitwith China:
Yuan appreciatedU.S.$ depreciated
Ceteris paribus, as a result of the above currency changes, U.S.would import less because imports become more expensive, and export more, causing the trade deficit to correct itself.
Problem for China: They want to continue exporting a lot to the U.S. to promote economic growth in their country.
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So the Central Bank of China intervenes in the FX markets to prevent the value of their currency from appreciating against the U.S. $, keeping it at a targeted value below E’. This also keeps the value of the U.S. $ at a targeted level above E’’.
They sell Yuan and buy U.S $ by entering into FX transactions with U.S. Banks.
D
S
D
SE’
E’’
value value
Q Q
Yuan Market U.S. $ Market
targettarget
Buy $Sell Yuan
S1
D1
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China uses their U.S. $ surpluses to buy U.S.government bonds.
The effect of China keeping the value of their currency artificially low from 2001-2006:
1.) U.S. trade deficits soared from 2001-2006 as wecontinued to buy cheap exports from China, financed by the Chinese who bought our government bonds.
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