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Now let's consider the topic [br]of currency manipulation.

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That's somewhat of an inflammatory name,

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you'll also hear this often called[br]currency intervention.

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The most common case [br]of currency manipulation

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or intervention,

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is when a country tries to hold down[br]the value of its currency,

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and they will do that by [br]buying and selling

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foreign exchange in global markets.

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There are a few different ways [br]we can draw this,

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but let's say we have a demand curve[br]for a currency,

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and a fixed supply curve.

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On the vertical axis, we have [br]the exchange rate for that currency,

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and on the horizontal axis,[br]we have the quantity.

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What a central bank can do is [br]increase the quantity of that money

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therefore, shifting out the supply curve[br]will have a new point of intersection

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and that will mean a lower exchange rate.

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Keep in mind that if the central bank [br]is taking that new money

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and using it to buy foreign currency,

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you can also show in the market [br]for that foreign currency

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that the demand for that currency [br]is going up,

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and the exchange rate [br]for the other currency is going up,

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and thus again, the exchange rate [br]for the domestic currency

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is going down.

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So why would a country want to lower [br]its exchange rate in this fashion?

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Well, the immediate impact [br]of the lower exchange rate

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is to make exports of that country[br]cheaper on world markets.

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And the goal very often is[br]to lower the exchange rate,

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boost those exports, and in the longer run[br]boost rates of economic growth.

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Think of this as an export-led [br]development strategy

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and it is partially implemented by[br]currency intervention or manipulation.

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Of course, currency manipulation [br]does not create new wealth,

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but rather, it's redistributing wealth.

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It's an implicit subsidy [br]to business exporters

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and an implicit tax on consumers [br]who are buying importers.

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One way to think about [br]how this might possibly work,

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is to imagine an economy where [br]you need a more commercial,

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or more business-oriented [br]set of interest groups,

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and that initially by subsidizing [br]some of your exporters,

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even though that's inefficient [br]in a lot of standard economic models,

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what you might be doing [br]is growing your middle class,

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growing your commercial class, [br]and over time,

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this might give you [br]a better economic policy.

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That maybe sounds a little strange [br]but if we look at history,

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we do actually find [br]a few cases where it seems

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this has definitely worked.

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And those cases would be Japan, [br]South Korea, and also China.

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Those are countries which deliberately [br]kept their exchange rates low,

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this helped their export-led growth, [br]and overtime those countries

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became much wealthier.

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Of course, it's not really [br]as simple as all that.

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The initial decline of the exchange rate [br]through currency intervention

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means that there's more [br]of the domestic currency out there.

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Over time, this tends to push up prices [br]in the domestic country

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and that means that over time, [br]that country tends to lose

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it's initial exchange rate advantage [br]from the currency manipulation.

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For more on exactly [br]how this process works

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see a video on nominal [br]verses real exchange rates.

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Sometimes governments or central banks [br]engage in what is called sterilization

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to prevent this new inflation [br]from coming into effect.

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So, if we see here that a government [br]increases the money supply,

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for the purposes of manipulating [br]an exchange rate,

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to limit the inflation, the government [br]has to pull that new money

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back out of the market[br]and they will do that basically

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by selling bonds [br]or some other asset

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thus bringing the money supply [br]back to it's initial level,

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and indeed, if you sterilize [br]in this fashion

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it means the inflation [br]will not happen.

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But think, what are you doing here? [br]

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By selling more bonds,[br]the government is borrowing money.

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This pulls resources out [br]of the real economy.

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It means higher taxes [br]either now or later,

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and this means, [br]that currency sterilization [br]

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imposes a very real burden [br]on the citizenry

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in terms of fewer real goods [br]and services in the economy.

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So, does manipulating [br]the real exchange rate

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in this entire manner actually work?[br]Well, it depends.

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What you're getting is a situation [br]where imports are more expensive,

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that's a burden on citizens.

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You're redistributing resources to your [br]corporate sector and your exporters,

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and basically, I would say,[br]that this strategy is dubious

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unless it's going to be accompanied [br]by some kind of growth miracle.

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So, definitely it has worked for Japan, [br]South Korea and China,

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but that doesn't mean [br]it's a general formula

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by which countries can become [br]more prosperous.

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For more on this topic [br]I recommend first of all,

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are videos on real and nominal [br]exchange rates,

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and also are specific video [br]on Chinese currency manipulation.

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There's a good piece by Sarno and Taylor [br]available online.

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You can also Google [br]some related topics listed here

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and see also Danny Rodriks piece,

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"The real exchange rate [br]and economic growth."