Where we left off in the last series of videos, we had the
Chinese Central Bank that was trying to make sure that the
yuan does not appreciate too much.
So the way they did that is that they bought up all of the
excess dollars using yuan that they printed.
So what they do is, they print yuan-- I'll do the yuan in
this blue color-- so they print yuan, and then they use
that printed yuan to buy dollars in the open market.
And what that does is it props up the demand for dollars and
keeps the price of yuan down, so then they get dollars.
So they print yuan and they buy dollars.
And as we saw, they have to keep doing this in order to
keep the yuan deflated, or in order to
keep the dollar inflated.
And this is so that they can maintain a
favorable balance of trade.
But as they do this, they're just building the stockpile of
dollar reserves.
And as we mentioned in the last video, they're not just
keeping a big vault of dollar bills there.
They're going to use it to buy assets, and they're going to
buy liquid and safe assets.
And the main asset they're going to buy is
U.S. Treasury bills.
So then they take these dollars and they buy U.S.
Treasury bills.
And let me draw some of the other actors here, because
they can buy it from two separate people.
There is the United States government.
So there is the U.S. Treasury.
They are going to issue Treasury bills, when they
essentially just need to borrow money.
And then there's other people that have already bought
Treasury bills.
So let me draw them over here.
So then there are other people who own Treasury bills.
So this is someone who owns a Treasury bill right over here,
wearing a hat, maybe with a little bit
of hair and a moustache.
So this is someone who owns a Treasury bill.
So just to give a review, when the U.S. government wants to
borrow money, people hand the U.S. government money-- I'll
draw it as a dollar bill, right over there-- they hand
the U.S. Treasury money, and then the U.S. Treasury gives
them an IOU.
This IOU is what a Treasury bill is, and what it entitles
the holder of this piece of paper to, it allows them to
get interest from the Treasury, depending on what
type of Treasury bill or bond it will be.
It'll be over a certain period of time.
I have a whole video on this, especially the ones where I
talk about the yield curve.
And then at some future date, the U.S. Treasury is going to
pay them a larger amount of money than they put back in.
So this right here is a Treasury bond or bill.
T-bill if it's a shorter duration, Treasury bond if
it's a longer duration.
This is a Treasury bond.
It is a loan to the U.S. Treasury.
Now, the Chinese Central Bank, they have all
these excess dollars.
They can buy treasuries from either two sources.
When the U.S. Treasury itself needs to raise funds, it will
essentially put these IOUs for auction.
It will sell them to whoever is willing to take them for
the least interest. So let me put it this way, so what they
can do is they can give the money directly to the U.S.
Treasury, when the U.S. Treasury puts Treasury bills
or Treasury bonds up for auction.
So it can give the money directly to the U.S. Treasury,
and then the U.S. Treasury will give them one of these
IOUs, or it could buy it from someone already has it out in
the open market.
This is a very deep, very, very liquid open market.
Or they can give these people right over here money, and
then they would transfer the IOU over to this Central Bank.
So what is happening at the Central Bank?
What is essentially happening here?
What's essentially happening is the Chinese Central Bank
printing money to buy dollars that it will then essentially
lend to the U.S. Treasury.
So it looks kind of convoluted, but the essence of
what is happening here is that the Chinese government, you
have the Chinese Central Bank lending to the U.S.
government.
And it might be buying other assets, but the Treasury bonds
and bills are really the main form of liquid asset they
might be buying.
So how does this affect the United States, other than the
fact that instead of owing other investors these IOUs, it
now owes it to the Chinese?
But what is the net effect of having this player out here,
having this very significant player out there, that is
fairly aggressively willing to pay for U.S. government IOUs,
U.S. treasuries?
What is the effect of that?
Well, we saw in the yield curve video that the more
people willing to give you a loan, the lower the interest
rates are going to be.
And I can show you a very simple example of that.
If I'm looking to borrow-- and I'm no longer talking about
nations, I'm just talking about Sal now-- let's say that
I'm over here, and I'm looking to borrow $10.
And I say, hey, who's willing to give me the best deal on
$10, and I'm going to pay you back next week.
So you might come along and say, I'll lend it to you for
10% interest over a week.
So you can pay me $11 next week.
So this would essentially be 10% interest over the week.
You give me $10 now, and if I agree to you, then I'll give
you $11 in a week.
That would be 10% interest.
But then let's say Mary comes along.
And she says, oh, I can do better than Mr. Orange Guy
over there.
This is Mary.
I'll lend you $10, and you can pay me $10.50 next week.
So notice what happened.
Both of these people have $10 to lend.
They're looking to get some return on their $10.
If he was the only player here, I'd have to go to him
and say, OK I'm going to pay you 10% interest. Then she
says, no, no, no, I also have $10 and, gee, I'd be happy
with just a 5% return.
$0.50 off of my $10 in one week, that's a good return.
So right now, look at this person.
But the more money that's available to borrow, the more
competitive this side of the equation is going to be, and
the lower the interest rate I can get.
You can imagine even a third person says, no, no, no, wait!
I've got $10.
Let me draw this third person, who says, I have $10,
and you know what?
It's going to just be sitting in my bank account doing
nothing unless I lend it to you.
You can pay me, I don't know, $10.25 next week.
And then I'm going to go to this person.
So the larger than the number of people willing to lend to
me, the lower my interest rate will be.
Or another way you could think of it, the larger the supply
of money to be lent, that leads to lower-- you can view
it different ways.
You could view it as lower borrowing costs, which is
another way of just saying lower interest. Or you can
even view it as cheaper money.
It costs less to borrow the money.
The cost of borrowing money is the interest.
Now, what does that do?
What does having lower interest?
So this is just a small example with me trying to
borrow $10.
The more people there are, the more competitive that is, the
better interest rate I'll have. So you just take that
same notion to kind of a macro level.
The U.S. government is constantly borrowing money.
The more people out there willing to give it money,
willing to buy the U.S. government's IOUs, the lower
the interest rate will be.
So the net effect of having this major buyer of U.S.
Treasuries is that having them out there accumulating all of
these dollars, taking them all out of the foreign exchange
markets and then using them to buy treasuries, it lowers the
interest rate for treasuries.
So the net effect is the U.S. Treasury has
lower borrowing costs.
So what does that mean?
So let's make it very clear.
So the Chinese buy treasuries, which are essentially loans to
the U.S. government, then the U.S. has
lower borrowing costs.
The U.S. has lower interest or borrowing cost. And I'm
talking about the government right now.
And this has several interesting side effects.
This means that it's easier for the
government to finance deficits.
They don't have to pay as much in
interest to finance deficits.
So that means that they can spend more.
They can give out more payments to U.S. citizens, or
they could lower taxes, either one.
Both of those would lead to deficits.
So it's easier so that the government can either spend
more or they don't have to raise taxes.
Or they could they could lower taxes, because they don't have
to spend as much in interest.
Now, the other interesting thing that the U.S. Treasury
borrowing costs go down, that means that the interest rate
on everything goes down.
This is one of the benchmark interest rates.
And you should watch the video on the yield curve if you want
to understand more about it.
And I know some of you are saying, wait, doesn't the
Federal Reserve set interest rates?
The Federal Reserve only sets overnight, very short-term.
If you're going to borrow money overnight in your bank,
that's what the Federal Reserve sets.
If the U.S. government is borrowing money over 5 or 10
years or 20 years, that is that by the market.
That is set by a market mechanism very similar to what
I showed just over here.
So this is dependant on more capital
being there to be borrowed.
So this is 10-year, and 15-year, and 20-year debt for
the U.S. becomes cheaper.
But this makes all debt in the U.S. cheaper.
And there's two ways you can think about
why this piece happens.
One is, just on a very superficial level, people say,
hey, you know, someone like General Electric is only a
little bit more risky than the U.S. government.
If the U.S. government only has to pay 3% on its on debt
that it has to pay back in 10 years, maybe General Electric
should only have to pay 0.3% more than that.
So you use the U.S. government as a baseline, and then
depending on people's risk, they pay a
little higher spread.
Another way to think about it is up here.
The Chinese government is just pouring dollars either
directly into the U.S. government, or into the actual
U.S. Treasury market.
So this guy right now, he has more dollars.
He's not going to use the Treasury, because he thinks
treasuries are too expensive, which means that their
interest is too low.
So he's going to take these dollars he got from the
Chinese, and he's going to lend it to someone else.
That dollar is still there.
He'll lend it to General Electric, or maybe he's a
credit card company and he'll lend it to the consumer.
So in general, all debt in the U.S. gets cheaper.
Now, what's the net effect of all of these points?
What's the net effect of this, all debt in the
U.S. Becomes cheaper?
There's just more dollars for loan in the U.S., more dollars
than people can borrow.
The government is spending more, or the government will
lower taxes.
What is the net effect of all of this?
Well, people will either have more money in their pockets,
because they've gotten a government job or they've
maybe gotten some type of entitlement payment.
Or, they're going to have more money in their pockets,
because they're paying lower taxes.
Or they're going to have more money in their pockets,
because it's easier for them to put more debt on their
credit card, or to refinance their mortgage.
So all of these lead to more cash in American pockets.
Now, that's obviously not an unambiguously good thing,
because this is all financed with debt.
It's not just solid debt-free cash.
So more cash in American pockets essentially
financed with debt.
And this debt, as you can see, it's either occurring at the
credit card level, it could be occurring even at the
corporate debt level, or it's occurring indirectly at the
government level.
But all of this is being enabled by the fact that China
is willing to buy treasuries, which means that China is
really just willing to lend to the U.S.
So what's happening?
China is artificially keeping its currency low, and it's
doing that by buying dollars, taking those dollars and
essentially lending them to the United States.
And that eventually ends up in the hands of American people
and companies, and even the government.
And what are they going to do?
Well, they're going to buy cheap Chinese products that
are artificially cheap because the currency is lower.
And obviously, you know, they do have lower labor costs and
all of that, but it's even lower to the American than it
would be if the currency were allowed to freely float.
So the net effect of this entire scenario that I've been
describing over the last few videos, is that the Chinese
are essentially lending money to the Americans to then go
ahead and buy more Chinese products.