Currency intervention
Encyclopedia
Currency intervention is the buying or selling of currency by central bank
s in an attempt to manipulate the price of a particular currency.
. Through its commercial bank it sells the U.S. dollars to the Chinese central bank, the People's Bank of China
. Since the trade between the United States and China does not balance, there is a shortage of yuan and a surplus of U.S. dollars in the Chinese central bank (therefore the Yuan must be 'created'). The usual remedy to this situation used in international trade would be for the Chinese central bank sell its dollars on international currency markets and buy yuan in exchange, resulting in a self-correcting system: the U.S. dollar weakens and the Chinese yuan strengthens, until equilibrium is restored and the trade gap closes.
However, in order to avoid this situation (which would decrease Chinese exports), the Chinese central bank chooses a different solution: it slows the appreciation of the Yuan, or in some cases effectively pegs the CNY against the USD. The central bank net buys USD, then sterilizes
the excess dollar flows by buying dollar-denominated assets, such as U.S. treasuries. This has the effect of keeping the excess dollars out of the currency exchange markets, where they would cause a correction in the exchange rates. Thus, the Chinese central bank manipulates the exchange rates by creating yuan and buying U.S. debt. This "printing" of Chinese Yuan by the central bank is not without consequence, however, since in excess (if yuan are created faster than domestic economic output) it would eventually lead to inflation, causing consumer prices to rise. Economist Paul Krugman writes that by keeping its currency artificially weak China generates a dollar surplus; this means that the Chinese government has to buy up the excess dollars.
, as it caused the money supply of gold in Europe to shrink (deflation).
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
s in an attempt to manipulate the price of a particular currency.
Japanese Yen
From 1989 to 2003, the Japanese economy was suffering from a long deflationary period. On June 2003, over a 15 month period, the Japanese central bank intervened in the YEN/USD currency markets by creating over 35 trillion Yen of currency ("printing" money). This currency was then used to buy 320 billion U.S. dollars, which were in turn invested into U.S. treasuries. This increased the supply of yen, weakening the yen against the dollar, improving exports and lifting Japan out of a deflationary period. At the same time, the U.S. was lifted out of the 2001-2003 recession with the ability to keep interest rates low, despite growing trade and government deficits.Chinese Yuan
When a consumer in the U.S. buys a Chinese product, Chinese manufacturers are paid in US dollars. These U.S. dollars are then deposited in a U.S. bank account. At this point, the Chinese exporter needs to convert dollars into yuanChinese yuan
The yuan is the base unit of a number of modern Chinese currencies. The yuan is the primary unit of account of the Renminbi.A yuán is also known colloquially as a kuài . One yuán is divided into 10 jiǎo or colloquially máo...
. Through its commercial bank it sells the U.S. dollars to the Chinese central bank, the People's Bank of China
People's Bank of China
The People's Bank of China is the central bank of the People's Republic of China with the power to control monetary policy and regulate financial institutions in mainland China...
. Since the trade between the United States and China does not balance, there is a shortage of yuan and a surplus of U.S. dollars in the Chinese central bank (therefore the Yuan must be 'created'). The usual remedy to this situation used in international trade would be for the Chinese central bank sell its dollars on international currency markets and buy yuan in exchange, resulting in a self-correcting system: the U.S. dollar weakens and the Chinese yuan strengthens, until equilibrium is restored and the trade gap closes.
However, in order to avoid this situation (which would decrease Chinese exports), the Chinese central bank chooses a different solution: it slows the appreciation of the Yuan, or in some cases effectively pegs the CNY against the USD. The central bank net buys USD, then sterilizes
Sterilization (economics)
Sterilization in macroeconomics refers to the actions taken by a country's central bank to counter the effects on the money supply caused by a balance of payments surplus or deficit....
the excess dollar flows by buying dollar-denominated assets, such as U.S. treasuries. This has the effect of keeping the excess dollars out of the currency exchange markets, where they would cause a correction in the exchange rates. Thus, the Chinese central bank manipulates the exchange rates by creating yuan and buying U.S. debt. This "printing" of Chinese Yuan by the central bank is not without consequence, however, since in excess (if yuan are created faster than domestic economic output) it would eventually lead to inflation, causing consumer prices to rise. Economist Paul Krugman writes that by keeping its currency artificially weak China generates a dollar surplus; this means that the Chinese government has to buy up the excess dollars.
United States and the Great Depression
During the 1920s, the U.S. government "sterilized" gold in-flows from Europe used to purchase products, in an effort to prevent the U.S. dollar from strengthening and hurting the export economy. This set the stage for the Great DepressionGreat Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
, as it caused the money supply of gold in Europe to shrink (deflation).