China buys US bonds

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China buys US bonds발음듣기

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In order to maintain a trade imbalance we know that the Chinese central government needs to keep its currency artificially weak.발음듣기

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And to do that they essentially can print their currency and use that to buy US dollars.발음듣기

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So what they do is they increase the supply of yuan and they increase the demand for dollars, keeping their currency weak.발음듣기

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Now, the next question you might ask is what do they do with the actual dollars that they bought with the yuan that they printed.발음듣기

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Well, they don't want to just sit on those dollars.발음듣기

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They'd prefer to be collecting some type of interest on that money.발음듣기

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So instead of just keeping it all in some warehouse someplace they actually just lend that money to the US government.발음듣기

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And they lend that money by buying US Treasury bonds, by buying T-bills and T-notes.발음듣기

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So that money that they use that they bought with their printed yuan, that goes to the US Treasury.발음듣기

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And the US Treasury gives the Chinese Central Bank treasury bonds.발음듣기

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So these are treasury bonds.발음듣기

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Now, what's the effect of this?발음듣기

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Clearly, the Bank of China is getting interest on its money now.발음듣기

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It's helping to finance the US government's debt.발음듣기

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But maybe even more interestingly, it is creating incremental demand for T-bonds, for treasury bonds.발음듣기

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Now, what does that do?발음듣기

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Well, if you're increasing the demand for anything that's also going to increase the price.발음듣기

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So the price of treasury bonds, of T-bills and T-notes, goes up.발음듣기

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T-bills are durations less than one year.발음듣기

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Notes are durations more than a year.발음듣기

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So the price goes up.발음듣기

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But what happens if the price goes up?발음듣기

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That means that the interest that the government has to pay on this debt goes down.발음듣기

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And I explained that in more depth in other videos.발음듣기

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Now, the interest goes down.발음듣기

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That means that the cost of borrowing for the US government goes down.발음듣기

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But that's also the benchmark rate for the cost of debt in general.발음듣기

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So in general it finances US debt, both of the government and really just credit more broadly.발음듣기

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So debt becomes cheaper inside of the United States.발음듣기

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This is Salman Kahn from the Khan Academy for CNBC.발음듣기

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