Why Are Interest Rates So Low? (Part 8)

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.

Why Are Interest Rates So Low? (Part 7)

In today's Khan Academy video, "Debt Loops Rationale and Effects," Sal looks at the positives and negatives--for both China and the U.S.--of the on-going pegging of the Yuan on global markets.  He discusses the likely outcome once the process is halted and the result when it is reversed.  Very simply, it has held interest rates low and enabled the U.S. to finance its massive debt at historically low interest rates.  Understanding this whole dynamic is crucial, IMHO, for the DIY investor going forward because it will be a driving force.  In fact, it could be the driving force of the next big crisis - banks hold Treasuries!  Central banks around the world hold the dollar as a reserve currency in the form of Treasuries.

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:

Why Are Interest Rates So Low? (Part 4)

The previous 3 posts presented short videos from the Khan Academy that covered some basics of international trade.  They showed a simple example of how a trade imbalance is resolved in a market of freely floating exchange rates.  They showed how currencies and prices adjusted.

Today's 7-minute video presentation, "Pegging the Yuan," takes us closer to the real world.  It begins to look at what happens if China wants to keep the currency at a level where demand for its goods stays high.  How does it do this?  What is the effect on U.S. interest rates?

This is especially interesting today because, as most market observers know, investment professionals expected Treasury yields to rise this year; and they actually fell.  It seems that, while everyone was focused on a Fed that was undertaking unprecedented monetary stimulus, less attention was directed to what the Chinese were doing in the currency markets.