Several readers this week have asked me exactly how does China impact the U.S. dollar's value? If you have questions, I am happy to answer them. Please post them on the forum, so other readers can benefit from the answer.
China has fixed the value of its currency, the yuan, to the dollar. Currently, a dollar is worth 6.8 yuan. Many analysts think it is artifically low. If China allowed its currency to float freely, it would be more valuable than the dollar because of China's strong economy, and it would rise. China does this to keep its products cheaper than U.S. products, thus increasing its exports to the U.S.
The only way China can keep the yuan artificially low is to promise to redeem dollars for yuan at the fixed rate. To do so, it must keep a good supply of dollars in reserve. Instead of holding dollar bills, it holds U.S. Treasuries, which it can quickly sell for dollars. As China's economy grows, it must buy more and more U.S. currency to meet the growing number of yuan.
What It Means to You
China has warned the U.S. to cut back on its debt, which is at $11.6 trillion and rising. China negotiated currency swaps with other G-20 trading partners, such as Hong Kong and Argentina. As China's need for the dollar declines, so will its appetite for Treasuries. This could cause interest rates to rise, hampering the revival of the U.S. housing industry.
Related Articles
- Is China Threatening to Sell U.S. Treasuries?
- Will Stimulus Package Reduce China's Purchases of U.S. Debt?
- Could a World Currency Replace the Dollar?
Photo: Chinese Premier Wen Jiabao (Credit: Liu Jin/Getty Images)
Comments
This brings the U.S./China economic relationship in clearer view. I see. Thank you.
From what I understand, China’s purchase of Treasuries supports the U.S. stimulus, which supports unemployment benefits, which indirectly subsidizes the housing market (the unemployed can pay their mortgages as they search for work) and the purchase of goods.
The latest Retail Sales report for July was down 0.6% (excluding the 0.5% cash-for-clunkers bump-up), which means there were fewer Chinese goods sold. At what point can the sale of China-made goods decline before the purchase of Treasuries becomes more expensive for the Chinese? Currency swaps will help China relieve the foreign-reserve pressure of holding a large percentage of dollars relative to other currencies, but how long will that last before other countries hold as many dollars as they need?
I look forward to further input and insight.
Great question. Look for an answer in a blog next week.
Kimberly
Recently in the United States of America and other parts of Europe it was announced that some of the big financial institutions, stock markets and companies have legaly declared bankrupt. For a professional economist he/she should raise arguement(s) and be able to justify how and why the above scenarior could happen.Actually it is the financial or ratio analysis tools that can radically explain the phenomenon.The liquidity and solvency ratios are the best tools to justify the occurance of financial crisis in an organizations.How?.Liquidity ratio tells us to what extent short term assets can be able to cover short term liabilities, therefore when the ratio is below one it implies the company is not not efficiently utilizing its assets to maximize wealth of shareholders but the situation does not cause an organization bankruptcy. On the other hand the solvency ratio measures the extend to which the organization dealing with financial speculation can be in a position to cover long term liabilities based on its long term assets. The ratio should be one or more than one otherwise it will be in a bad perfomance to the extend that it may legally declare bankrupt as it happened in the united states and other Metropolitant nations.
No country’s government in this world has declared bankruptcy but what is the implication of the current economic situation in our country,high learning instituation demonstrations, teachers demonstrations,the East African former workers claims on payments, TRL workers demonstration and other sectors of the economy having unsatisfactory financial suport from its government. Does this mean that our government has gone bankrupt to the extent that it is not capale of covering its expenditures on recurrent and development expenditure? if so then it should legally declare bankruptcy kisha tuuze mashangingi tugawane kilichopo.
without jocks the situation will be much worse in the coming days for tanzania classified as LDC country because of heavy reliance on financial support from upcountries which are currently having an inward looking economic policies to recontruct their economies.
DOES THE ARGUEMENTS POSED SOUND CORRECT?
To Eleuter Kihwele’s comment:
You are right in saying that companies with liquidity and/or solvency ratios less than one are in undesireable positions, but does not necessarily mean they are headed toward bankruptcy.
While states and nations can become bankrupt (or insolvent), there is currently no national / international framework for them to declare bankruptcy. Originally, process of bankruptcy was created to give creditors the right to acquire the assets of the debtor. It would take an act of war for a nation to acquire the assets of another. In the case of Zambabwe or Iceland, when finances go awry, lending countries simply have to wait until their governments get the nation back on track and/or renegotiate financial terms.
Nations, states and municipalities should always be looking for ways to structure or restructure their economies in a way that keeps them from depending on borrowed money, or limits negative impacts when times are hard. The borrowing binge the US is on disturbs me greatly. And states such as California, Michigan and Pennsylvania are having a hard time, too, due to declining tax revenues. Teachers, government workers, governments that depend on foreign aid – they all are understandably anxious about their futures.
Let’s hope government officials get things right soon so that we will never have to entertain the idea of creating national or international bankruptcy processes. I appreciate your comments.
Tony,
Thanks for providing such a great answer to Eleuter’s question.
Here is an example of how Iceland went bankrupt
Iceland Bankruptcy.
An how the U.S. is moving closer towards bankruptcy
Could the U.S. Go Bankrupt?
Kimberly
HOW DOES CHINA’S MONEY COMPARE TO THE US DOLLARS?
1 U.S. dollar = 6.82910839 Chinese yuan
How did China get such a large amount of dollars in its reserve. Does US pay China in dollars for imports? If this is the case, then does China pay US in yuans for products they import from the USA.
Most international trade is done in dollars. China got so many dollars by exporting more to the U.S. than it imports (see China – U.S. Trade Deficit). It also buys dollars through U.S. Treasuries – about $800 billion as of October 2009.
Kimberly
Kimberly, thanks for this informative piece. On your explanation about China’s selling US treasury bonds in order to keep sufficient reserve of dollars, wouldn’t China’s selling bonds on the open market reduce the money supply, and therefore causing the dollar to increase against yuan? Is one correct to think that those bond sales would take dollars out of the market, and cause it to appreciate?
Great question, Mike.
The value of the dollar depends on what forex investors think it is worth. It reflects their opinion of the money supply as well as the strength of the U.S. economy in comparison to other investments. It takes into account the supply of actual dollars, Treasury bonds and credit issued by the Federal Reserve.
It also takes into account the size of the U.S. debt and whether investors think the government will let the value of the dollar decline in the future so it can pay back the debt with cheaper dollars.
Forex investors also look at the projected fed funds rate and interest rates relative to interest rates paid on other currencies by their central banks.
This is why it is so difficult to make money trading currency – there are so many moving parts.
Kimberly
what do you think, i know???
THIS IS IN AU $, IT = OUT TO BE THE SAME ANYWAY.
The first thing the government will do is start a new $22,000 first home, but, used home grant.
The government will buy $50 billion dollars of solar panels, in big bulk, to get a good deal. The government will then include a electric hot water system, that they will buy in mass bulk to save mass money. The government will also buy a electric stoves in mass bulk, making it, buy 1 million, get 50,000 for free. so it works out to cost them $700 instead of $1,000. same goes for a hot water system, they buy 1 million worth of hot water system, and pay $1,000 dollars, instead of $1,400, or save even more.
The government will get a mass deal on $50-$200 billion dollars worth of solar panels.
The government will make that, the people get $20,000 worth of solar panels, that is in big bulk too, it should = $30,000 worth.
They will also get a $1,000 electric hot water system & a $1,000 stove / oven, it’s all gotten in big bulk too. Save mass money & start lots of jobs.
Now mass people can buy houses. If people get free solar panels, they don’t pay electricity bills. If they get free electric stoves and hot water systems, they don’t get gas bills. so people will save on average $3,600 a year, or more. so people will save about $300 a month.
If people save $300 a month, people on minimum wages could by a home / get a home loan easy. People that get better then minimum wages, could get a home loan easy.
If people save $300 a month, they could pay off a houses easy. Each month there morgage payments / home loan payments, will be $890 a month. if they save that money from no gas bills or power bills, they can take $300 dollars a month, off there loan repayments.
If people save that $300 a month, there repayments would be $590 a month instead of $890.
Now People pay more then that a month on renting a house. even if it cost them now $990 a month for loan repayments, it will cost them $690, still way cheaper then renting, and would hit the banks amount of money you need to get a loan and afford to pay it off.
Houses are so cheap now, & they will get to take a extra $300 off there home loan repayments every month, so mass people will buy houses now.
If the government does this, mass houses will be sold, then they will start a, brand new first home solar grant.
The government would first / at same time, spend
$200 billion $ on buying houses, so they can control the housing market.
The government will buy 200 billion $ worth of houses all over America, in key areas. The government would then rent 90% of them houses out, fixing a renting crises at the same time.
Once
The government does that, they control the houses market / interest rates, by relicing houses onto the market, if the prices of houses go way up.
The government can control the housing market by relicing houses onto the market, by flooding houses
to lower the price.
The government can also rise the prices of houses, by buying up all the houses after they buy lots of houses, & start mass houses being sold.
As long as they buy them all of them houses cheap now, they will not have to buy many latter to control the housing market.
So many people will buy houses now, along with the government.
Right Now if people go to buy a house, there is not even 2 people bidding on a house, that creates no compaction no bidding, no market. that’s why the housing market is no more. If the government starts a used first time home buyers grant, and the government spend $200 billion $ on buying houses, the house prices will go up a big % over 2 years. once they do that, there will not be many houses on the market after that, and there will be 20 people bidding on 1 of the limited houses for sale in 2 – 5 years, & that creates compaction, that creates houses going up in prices.
If peoples houses go up, many people will sell there houses and buy a different house. right now there houses are worth nothing, so they can not move or buy a different house, its just the way it goes / works. if your house cost you with a loan $600,000, you can not sell it for $200,000, nor would you even if you paid $600,000 cash with your own money / no home loan. once the prices of houses goes up, many people will sell there houses and move, and buy a different house, as them people sell there house, other people buy there house and sells there’s as well, showing the housing market mass houses sales, but really, they are just swapping houses, but the real estates will show mass houses being sold.
So first the government will start a used first home grant, that will give people free solar panels & electric stoves & hot water systems. That will take away there power bills & gas bills giving them a extra $300 plus to pay off the home loans.
The government will also buy $200 billion $ worth of houses, to control the housing market, by relicing house onto the market if they get to dear, that will lower house prices if they flood houses onto the market and then do this to control it properly.
In 1 to 2 years time, the government will start a brand new first home solar grant, that will start more mass houses being built.
To control the housing / market, the government will also need more houses been built, to free up demand, or there will not be houses for sale, and houses prices will be way way to high.
The government can control the housing market, as long as after all them used / 2 million houses become limited, more houses are built to help them.
If the government does not start a first home solar grant, they will lose control or the housing market / house prices. That because all the old / used houses will be sold, there for there is no houses for sale, or only had fulls seeing, will 100 people bidding on 1 house.
If that was to happen, the government could only relic house for a amount of time, unto they are all sold, then they would lose control of the house prises / interest rates. Thai is why they will mix it up, to stop that from happening.
So the government will spend $200 billion dollars on buying houses, that will only allow them to relic houses up to a point / they will run out in 4 years time, because there is to much demand / everyone has got a house, buying up all the houses on the market now. so the government will mix it up. The first year it will be a, first home used home buyers grants, used house grant, & at the same time the government will mop up $200 billion $ worth of houses. then after 1 year, it will be brand new first home grant, that 0r 60% used houses & 40% new houses, to get people buying up used houses to first, to rise the house prises a bit, then the other 40% will be new houses being built, to make shore the government will not lose control the housing prices, buy relicing some houses to lower the prices a bit, if they have to lower the price in a bad time.
So you first what to get most of the houses flooded on the market now sold. that will rise the house prices a bit.
After that happens, you want new houses to be built to start mass jobs and too stabilise your control in the housing market.
The government does not want to sell all there houses to lose control of interest rates & the housing market.
If the government buys the $200 billion dollars worth of houses & starts a new used first home buyers grant, they will get 85% of them houses off the market rising the prises of houses a bit, then they start a brand new first home grant to stop people buying up all the houses, sending the prices up 400%, because all the house are sold, & there is non left. So thy control it buy stoping a used first home grant once 85% of used houses are sold, & starting a first home solar grant, to have more houses on the market, letting them control the prices, by relicing houses to lower the prices, and buy making people buy brand new houses after 90% of the old houses are sold, that would stop all of the houses being sold, that will stop rising the prices of houses so so high, & interest rates.
So if you start a new house grants, people will only buy a new house, stooping every old / houses being sold, that stops sending the prices way to high, that you want to control. new houses are being built, so used houses are not all being sold now.
If the government just keeps just doing used house first home solar grants, all the houses would be sold, and they would have to sell off all there houses very fast, losing control of the market.’ if they let mass / 92% of used houses get sold, then start brand new home grants, they will not need to sell of there houses. the grant is now for new houses only, not used houses, so they will leave 8% of houses free on the market. that would send prices up a bit, but there is still 8% of houses on the market, and they can then relic a extra 7% to bring the houses back down to what they want.
The GOVERMENT only let people build houses with the grant, letting them control the housing market forever just about. if used house start to drop off leaving say, 19% on the market, they just change the first used home grant, too brand new house solar grant. this is the way you fix the housing market and control the prices. it will work and start a mass houses being sold, then latter mass new houses being built, that start mass building jobs. the point is to control it, if everyone buys a house in 7 years, the housing market will full. control it and house prices. this is the only way America and all allied country’s can get out of this housing mess, but at the same time, it will start a housing boom, why going green as well, why starting mass jobs that would more then kick start Americas / the west’s economy’s. it would see a surge in the economy / big growth. we must takeaway the power and gas bills. that will allow people to pay off used houses then brand new houses on minimum wages, and people that get more then that, can also build new houses with ease.
The point is.
1, they start a used home solar grate to get mass houses sold, & take away gas & power bills to allow mass people afford houses. they also buy mass houses to control the prices.
2, they then start a brand new home solar grants, when to many houses are sold, to stop a housing market with no houses / house are 2 million dollars each / to dear, and so the government can control the market.
3,once they force people to buy a new houses, the demand will drop off & all used houses will not be sold, there for the government just relices some of there houses, dropping the prices.
4. They control it buy relicing houses, & by start a new houses grant that everyone will have to do, to afford the home loan. That lets them own 25% of the houses left on the market for sale, because everyone is now building new houses because they have to / save $300 a month because that’s the grant now.
5. All the government has to do is, dump 10% of there houses extra onto the market, know one will buy them because the first home solar grant, is on new houses. there for the prices will drop along with interest rates.
6. They can make it what ever they want the price to be, as well as interest rates. No one can afford a houses with out the grant just about, & any one selling there houses once the price goes up, will be buying the other person house that did the same thing.
First home grant, if you own a house and sell it, you can not get the grant, first home buyer grant.
In the end they will do second brand new home solar grants, but that would not be for a very long time.
creating mass jobs
The government also need to cut taxes on each company. just $750 for a small company, so he can hire 1 more worker for free. bigger company’s can hire 20 more people for free. the key is to forcing de-faco partners on the doll / government payments, to get a job first. in Australia they would get about AU$1,350 every 2 weeks. if the man got a job at, well say he earns AU$750 A week, they would only get $80 child / kid government payment that everyone gets. he would pull in $1,580 every 2 weeks. the government would save $1,220 a fortnight. if she gets a job as well, they would be way better off, but because he earns that much money, there pay would be cut by 96%. the key is to target the jobs to people that get the most money on government payments. first at least 1 person in a de-facto relationship must get a job. but really both of them a job first. if the government got them both a job, not only would they save $1,300 a fortnight, they would also get taxes from there wages / work pay. the government would start a new daycare rebate of 7% of the cost at the end of the year. they get that money 2 weeks before Christmas. that will also see big spending’s at Christmas time, flexing the economy.
Also force everyone to put AU$3-5 extra into there supper fund. that money can only be invested in there country too. times that buy 220 million people, times 52 / a year. that would start mass mass jobs as well.
I hear people saying that China every once in a while will threaten to dump its US dollar holdings or demand some of its loan back. Are these two different actions, and what would be the result if China did follow through on their threats?
Hi Anna,
China holds dollars via Treasuries, which are loans. So, yes, if China dumped dollars, it is the same thing as demanding its loan back. It would simply sell the Treasuries it owns on the secondary market and demand the payment in a other than the dollar.
The effect would be downward pressure on the dollar, since there would be more dollars in circulation. More important, it would signal to the rest of the world that China was getting out of dollars, which could possibly lead to a dollar collapse.
Find out why China would not want that to happen in Is China Threatening to Sell Treasuries?
Find out how to protect yourself from a dollar collapse in Protect Yourself from a Dollar Decline.
Kimberly