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Tuesday, December 20, 2011

Why Are Interest Rates So Low? (Part 5)

In this 16-minute video, Sal of Khan Academy takes us real close to understanding an important dynamic taking place in the global capital market that has held interest rates down and has been a bit underappreciated.  Here he shows how the Chinese Central Bank needs to constantly print Yuan and use that Yuan to buy U.S. dollars to maintain the peg between the Yuan and the U.S. dollar.  They do this to produce an ongoing trade surplus with the U.S. - i.e., to sell more goods to the U.S. than it buys from us to support its industries.

The key is what they do with the dollars bought with the Yuan they print.  As Sal points out, they need to put this massive accumulation in something that is safe and liquid, i.e. U.S. Treasuries.

Just this morning there is a report that Japan wants to increase the amount it can intervene with in currency markets to prevent the Yen from rising further.  So this whole process is not just unique to China.  Countries have an incentive to keep their currencies from appreciating versus the world's reserve currency!

Enjoy the video:

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