Now let's consider the topic of currency manipulation.
That's somewhat of an inflammatory name,
you'll also hear this often called currency intervention.
The most common case of currency manipulation
or intervention,
is when a country tries to hold down the value of its currency,
and they will do that by buying and selling
foreign exchange in global markets.
There are a few different ways we can draw this,
but let's say we have a demand curve for a currency,
and a fixed supply curve.
On the vertical axis, we have the exchange rate for that currency,
and on the horizontal axis, we have the quantity.
What a central bank can do is increase the quantity of that money
therefore, shifting out the supply curve will have a new point of intersection
and that will mean a lower exchange rate.
Keep in mind that if the central bank is taking that new money
and using it to buy foreign currency,
you can also show in the market for that foreign currency
that the demand for that currency is going up,
and the exchange rate for the other currency is going up,
and thus again, the exchange rate for the domestic currency
is going down.
So why would a country want to lower its exchange rate in this fashion?
Well, the immediate impact of the lower exchange rate
is to make exports of that country cheaper on world markets.
And the goal very often is to lower the exchange rate,
boost those exports, and in the longer run boost rates of economic growth.
Think of this as an export-led development strategy
and it is partially implemented by currency intervention or manipulation.
Of course, currency manipulation does not create new wealth,
but rather, it's redistributing wealth.
It's an implicit subsidy to business exporters
and an implicit tax on consumers who are buying importers.
One way to think about how this might possibly work,
is to imagine an economy where you need a more commercial,
or more business-oriented set of interest groups,
and that initially by subsidizing some of your exporters,
even though that's inefficient in a lot of standard economic models,
what you might be doing is growing your middle class,
growing your commercial class, and over time,
this might give you a better economic policy.
That maybe sounds a little strange but if we look at history,
we do actually find a few cases where it seems
this has definitely worked.
And those cases would be Japan, South Korea, and also China.
Those are countries which deliberately kept their exchange rates low,
this helped their export-led growth, and overtime those countries
became much wealthier.
Of course, it's not really as simple as all that.
The initial decline of the exchange rate through currency intervention
means that there's more of the domestic currency out there.
Over time, this tends to push up prices in the domestic country
and that means that over time, that country tends to lose
it's initial exchange rate advantage from the currency manipulation.
For more on exactly how this process works
see a video on nominal verses real exchange rates.
Sometimes governments or central banks engage in what is called sterilization
to prevent this new inflation from coming into effect.
So, if we see here that a government increases the money supply,
for the purposes of manipulating an exchange rate,
to limit the inflation, the government has to pull that new money
back out of the market and they will do that basically
by selling bonds or some other asset
thus bringing the money supply back to it's initial level,
and indeed, if you sterilize in this fashion
it means the inflation will not happen.
But think, what are you doing here?
By selling more bonds, the government is borrowing money.
This pulls resources out of the real economy.
It means higher taxes either now or later,
and this means, that currency sterilization
imposes a very real burden on the citizenry
in terms of fewer real goods and services in the economy.
So, does manipulating the real exchange rate
in this entire manner actually work? Well, it depends.
What you're getting is a situation where imports are more expensive,
that's a burden on citizens.
You're redistributing resources to your corporate sector and your exporters,
and basically, I would say, that this strategy is dubious
unless it's going to be accompanied by some kind of growth miracle.
So, definitely it has worked for Japan, South Korea and China,
but that doesn't mean it's a general formula
by which countries can become more prosperous.
For more on this topic I recommend first of all,
are videos on real and nominal exchange rates,
and also are specific video on Chinese currency manipulation.
There's a good piece by Sarno and Taylor available online.
You can also Google some related topics listed here
and see also Danny Rodriks piece,
"The real exchange rate and economic growth."