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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,
-
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."