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Now let's consider the topic 
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
currency intervention.

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The most common case 
of currency manipulation

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or intervention,

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

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and they will do that by 
buying and selling

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foreign exchange in global markets.

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There are a few different ways 
we can draw this,

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

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and a fixed supply curve.

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

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and on the horizontal axis,
we have the quantity.

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

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therefore, shifting out the supply curve
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 
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 
for that foreign currency

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that the demand for that currency 
is going up,

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and the exchange rate 
for the other currency is going up,

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and thus again, the exchange rate 
for the domestic currency

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is going down.

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

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Well, the immediate impact 
of the lower exchange rate

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

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And the goal very often is
to lower the exchange rate,

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

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Think of this as an export-led 
development strategy

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and it is partially implemented by
currency intervention or manipulation.

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Of course, currency manipulation 
does not create new wealth,

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but rather, it's redistributing wealth.

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It's an implicit subsidy 
to business exporters

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and an implicit tax on consumers 
who are buying importers.

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One way to think about 
how this might possibly work,

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

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or more business-oriented 
set of interest groups,

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and that initially by subsidizing 
some of your exporters,

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

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what you might be doing 
is growing your middle class,

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growing your commercial class, 
and over time,

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this might give you 
a better economic policy.

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

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we do actually find 
a few cases where it seems

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this has definitely worked.

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

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Those are countries which deliberately 
kept their exchange rates low,

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

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became much wealthier.

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

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The initial decline of the exchange rate 
through currency intervention

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

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

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and that means that over time, 
that country tends to lose

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

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For more on exactly 
how this process works

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see a video on nominal 
verses real exchange rates.

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Sometimes governments or central banks 
engage in what is called sterilization

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to prevent this new inflation 
from coming into effect.

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

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for the purposes of manipulating 
an exchange rate,

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to limit the inflation, the government 
has to pull that new money

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back out of the market
and they will do that basically

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by selling bonds 
or some other asset

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

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and indeed, if you sterilize 
in this fashion

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it means the inflation 
will not happen.

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But think, what are you doing here? 


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By selling more bonds,
the government is borrowing money.

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This pulls resources out 
of the real economy.

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It means higher taxes 
either now or later,

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and this means, 
that currency sterilization 


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imposes a very real burden 
on the citizenry

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in terms of fewer real goods 
and services in the economy.

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So, does manipulating 
the real exchange rate

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

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What you're getting is a situation 
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 
corporate sector and your exporters,

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and basically, I would say,
that this strategy is dubious

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

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

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but that doesn't mean 
it's a general formula

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by which countries can become 
more prosperous.

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For more on this topic 
I recommend first of all,

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are videos on real and nominal 
exchange rates,

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and also are specific video 
on Chinese currency manipulation.

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

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You can also Google 
some related topics listed here

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and see also Danny Rodriks piece,

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"The real exchange rate 
and economic growth."