In this final, 4-minute Khan Academy video on currencies, "China Keeps Peg But Diversifies Holdings," Sal notes that China's holdings of U.S. Treasuries are decreasing as they diversify their holdings but other countries holdings of Treasuries are increasing. In fact, globally the rest of the world has to do something with the excess of the amount we buy from them versus what they buy from us, i.e. our trade deficit. They buy Treasury issues because they are liquid and safe and can be bought in very large amounts.
So, the end result is that China buys Treasuries to peg their currency below the market rate which results in a humongous demand for Treasuries, driving Treasury prices higher and rates lower. This is a major factor holding U.S. rates low and expanding the U.S. trade deficit. It holds Treasury rates lower than they would be otherwise as well as the rates on other issues. B y doing this, China is able to build their manufacturing base. Eventually they should reach the point where they create a middle class to buy the goods they produce.
To me, the Khan Academy videos are a treasure. For those interested in understanding how the economy works and financial markets, I suggest visiting the site on a regular basis and viewing the videos systematically. To keep up-to-date on events, check out the new videos he is constantly producing. Eventually your understanding of markets will become much more sophisticated. I actually believe that many big-time money managers didn't fully appreciate the impact on rates described by Sal in the videos we have viewed this week.
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