Now let's consider the topic 
of currency manipulation.

That's somewhat of an inflammatory name,

you'll also hear this often called
currency intervention.

The most common case 
of currency manipulation

or intervention,

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

and they will do that by 
buying and selling

foreign exchange in global markets.

There are a few different ways 
we can draw this,

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

and a fixed supply curve.

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

and on the horizontal axis,
we have the quantity.

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

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

and that will mean a lower exchange rate.

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

and using it to buy foreign currency,

you can also show in the market 
for that foreign currency

that the demand for that currency 
is going up,

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

and thus again, the exchange rate 
for the domestic currency

is going down.

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

Well, the immediate impact 
of the lower exchange rate

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

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

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

Think of this as an export-led 
development strategy

and it is partially implemented by
currency intervention or manipulation.

Of course, currency manipulation 
does not create new wealth,

but rather, it's redistributing wealth.

It's an implicit subsidy 
to business exporters

and an implicit tax on consumers 
who are buying importers.

One way to think about 
how this might possibly work,

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

or more business-oriented 
set of interest groups,

and that initially by subsidizing 
some of your exporters,

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

what you might be doing 
is growing your middle class,

growing your commercial class, 
and over time,

this might give you 
a better economic policy.

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

we do actually find 
a few cases where it seems

this has definitely worked.

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

Those are countries which deliberately 
kept their exchange rates low,

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

became much wealthier.

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

The initial decline of the exchange rate 
through currency intervention

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

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

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

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

For more on exactly 
how this process works

see a video on nominal 
verses real exchange rates.

Sometimes governments or central banks 
engage in what is called sterilization

to prevent this new inflation 
from coming into effect.

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

for the purposes of manipulating 
an exchange rate,

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

back out of the market
and they will do that basically

by selling bonds 
or some other asset

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

and indeed, if you sterilize 
in this fashion

it means the inflation 
will not happen.

But think, what are you doing here?

By selling more bonds,
the government is borrowing money.

This pulls resources out 
of the real economy.

It means higher taxes 
either now or later,

and this means, 
that currency sterilization

imposes a very real burden 
on the citizenry

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

So, does manipulating 
the real exchange rate

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

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

that's a burden on citizens.

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

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

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

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

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

by which countries can become 
more prosperous.

For more on this topic 
I recommend first of all,

are videos on real and nominal 
exchange rates,

and also are specific video 
on Chinese currency manipulation.

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

You can also Google 
some related topics listed here

and see also Danny Rodriks piece,

"The real exchange rate 
and economic growth."