Yuan or Yen

by Elaine Schwartz    •    Mar 27, 2010    •    743 Views

Harvard professor Niall Ferguson, called China a currency manipulator in a recent interview. Next month, Treasury Secretary Tim Geithner will let us know if he agrees. The United States has not formally called China a currency manipulator since 1994.   

According to a Planet Money podcast, this is why China could be called a currency manipulator:

1) A U.S. business buys Chinese made goods. 2) The U.S. business pays for its purchase in dollars. 3) Needing yuan and not dollars, the Chinese factory uses its dollars to demand yuan at a local bank. 4) Here is the tricky part. Lots of quantity demanded for yuan should shove its price up.  But it does not. Why? Because the Chinese government adds to the yuan supply which shifts the supply curve downward and maintains the price of the yuan. China’s intervention could be called currency manipulation.

Next question.  Why should we care?  We care because when a currency is too cheap, world demand for that nation’s goods soars and production elsewhere suffers.  If left alone, though, currencies self-correct. As quantity demanded increases for a cheap currency, it becomes more expensive. Soon, people buy fewer goods from that country and more from other nations whose goods become relatively cheaper.  Like a seesaw, currency values go up and down, always equalizing as long as governments do not interfere.  

The Economic Lesson

How does money become more or less expensive? As always, it is all about demand and supply. Buyers want more goods and services that they buy for yuan or yen when they are cheap and less when they cost more.

Yuan or yen?  If each fluctuated freely, it would depend on demand and supply.


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