Articles

Currency Effect on Trade

February 25, 2020


What I want to do in this video
is explore how trade imbalances, in theory, should be
resolved by freely floating currencies. So let’s just say in the
beginning of our time period, like we did in the last video,
that the exchange rate between the Chinese yuan and the
U.S. dollar is 10:1. So we have 10 yuan. So the last time people traded
these currencies, they exchanged 10 yuan for
1 U.S. dollar. And, when I say, dollar, I’m
going to implicitly mean the U.S. dollar. Now, let’s think about two
entrepreneurs in each of the countries, or one in each
of the countries. So let’s talk about a Chinese
entrepreneur. So we are in China here,
and he makes dolls. And in order to profitably sell
a doll, he needs to sell them for 10 yuan. If he’s able to sell for the
equivalent of 10 yuan in the United States– and we won’t
talk a lot about shipping and what currency you’d have to pay
and all of that– then he can pay all of his needs. Maybe even the shippers across
the Pacific, maybe their employees are also Chinese. So they want their
money in yuan. And, obviously, most of
the cost would be for manufacturing this doll. And all of his employees want
to be paid in yuan. His own rent for the factory,
or even his own rent for his own house, all has to
be paid in yuan. So this is what he needs to sell
his doll for, 10 yuan. And at the current exchange
rate, that would be $1. Now, let’s go across
the Pacific. Let’s go to the United States. And let’s say that we have
another entrepreneur who is making soda, or making
cola, for export. So let me draw a can of cola. And similar to this guy in
China, he needs to sell his product abroad for the
equivalent of $1, so that it can cover shipping costs,
manufacturing costs, and the high fructose corn syrup,
and all of that. And once again, he cares
about dollars. Because he has to pay his
own mortgage in dollars. His employees need to
be paid in dollars. Maybe the shippers he used,
they only accept dollars. So this is how both of these
characters think about it. Now, at the current exchange
rate, let’s say that there’s a demand for 100 dolls in
the United States. This guy is exporting. And so is this guy. We’ll make it very simple. They’re only focused
on exports. So at current exchange– and
I’ll do it for both– for the doll guy, there is demand
for 100 dolls in the United States. So what does that mean? That means that if he can sell
these dolls for $1, which is equivalent to 10 yuan, then
there’s going to be 100 people in some time period, let’s say
it’s a year or month, who are going to be willing to buy
the dolls at that price. And let’s say, also at this
current exchange rate, in China, 50 people are willing
to buy this cola. So at the current exchange
rate, demand for 50 cans in China. Obviously, these are
ridiculously low numbers. But we’re just dealing
with simple numbers to help our thinking. Let me write the at current
exchange rate as well. So what we’re saying is that, in
China, he needs to get $1. At the exchange rate,
that’s 10 yuan. So if he were to, at a store in
China, or to a distributor in China maybe, sell each of
these cans for 10 yuan, there’s demand for
50 cans in China. Now, what’s going
to happen here? I think some of you all might
already see that a trade imbalance is developing. So what’s going to
happen here? So this guy, he likes
doing this. And this guy like doing it. So what’s going to happen in
this time period, this Chinese guy is going to ship over 100
dolls to the United States. Let me write this down. This is China. This is the U.S. over here. And what’s the U.S.
going to do? Well, the U.S. is going to ship
over– remember, he’s selling this in the
United States. So each 10 yuan is $1. So for each doll, he’s
going to get $1. So he’s going to
get back $100. He is going to get back
$100 for his dolls. And then once he gets back $100
for his dolls, he’s going to want to convert
them into yuan. So then he will try to convert
the $100 into yuan. So this is what’ll end up
happening for this guy. And let’s say these are the
only two people trading between China and the United
States, just to really simplify things. Now let’s think about
what happens on the right side over here. This guy is going to ship
50 cola cans to China. He is going to ship 50
of them to China from the United States. And what is he going to
get back in return? Well, it’s being sold to
Chinese distributors. So they’re going to
pay him in yuan. So for each can, at the current
exchange rate, or at the current price, he’s
going to get 10 yuan. So when you convert it
back, he’s going to get 10 yuan per can. So 10 yuan times
50 is 500 yuan. 500 yuan is what he’s
going to get. And then, he’s going to try to
convert– let me write that in a different color just really
for the sake of it. So he’s going to try to convert,
because he has to pay his expenses his dollars, his
500 yuan into– Now, what’s the exchange rate that he
wants to, his goal is? To cover his costs, he
has to get 10:1. So 500 yuan into $50. And let me make it clear. This guy thinks he’s going to
get 10 yuan for every dollar. So he wants to convert his
$100 into 1,000 yuan. Let me write it here. 1,000. I should have written
it over here. So what just set up? If these are the only people
trading goods and currency in this time period, what
did we just set up? Well, clearly, this guy is
shipping more value to the U.S. than this guy is
shipping to China. There’s a trade imbalance. If you think of it in terms of
dollars, this guy is shipping $100 worth of goods to the U.S.
This guy is only shipping $50 worth of goods to China. So there’s a net trade
imbalance of $50. China is shipping $50 more to
the U.S. Then, the other way around, if you think about it
in yuan, it would be a trade imbalance of 500 yuan. And because of that, this guy is
trying to convert many more dollars into yuan than this guy
is trying to convert the other way around. Notice there is more demand
for yuan than dollars. What’s going to happen,
especially if these are the only two people trading? If these are the only two people
trading, this guy is going to say, hey,
I’ve got 10 yuan. Let me convert it
into dollars. It’ll be just like what we
saw in the last video. And, obviously, there’ll
be more actors here. But this guy has more stuff
to convert than this guy. In fact, if these were the only
two people trading, he wouldn’t even be able to
convert all of his currency into yuan. Because there’s only 500 yuan
available on the market. This guy thinks he should
get 1,000 yuan. And, obviously, if the price
of the yuan goes up, like we’ve seen in the previous
video, maybe there will be more people who want to convert
yuan, or maybe fewer people who’d want to
convert dollars. So we can think about
all of those. But I really want to think
about how this will potentially resolve the
trade imbalance. So we have a situation
with more demand for yuan than dollars. There’s a demand for
1,000 yuan here. There’s only 500 yuan
being sold. Or you could view it
the other way. There’s only demand for $50. And there’s $100 being sold. Either way there’s
an imbalance. So what’s going to happen? Well, you’re going to have
either, depending on how you want to view it– you could
say that the price of the dollar will go down. Or you could say that the price
of the yuan will go up. And the dynamics would be like
we saw in the last video. This guy over here would sell
a couple of his yuan. And he’d say, wow, there’s this
guy over there who really wants to buy it. And then maybe he’ll keep
saying, instead of giving me a dollar for every 10 of my yuan,
why don’t you give me a dollar for every 9 of my yuan? Or eventually, why don’t you
give me a dollar for every 8 of my yuan? And so he’ll keep raising
the price of the yuan. He’ll keep giving fewer
and fewer yuans for each of the dollar. Let’s say this goes on
for a little bit. And I really want to explore
the trade imbalance. Let’s say at some point– and,
obviously, maybe more and more people come into the market. So, eventually, it clears. Because, right now,
there isn’t enough yuan for this guy. But as you can see, the price
of the yuan goes up. So after all of this, because
of this trade imbalance, because more people want to
convert dollars into yuan than yuan into dollars, the
currency changes. So you could imagine– and I’m
just going to make up some numbers here– that the yuan
becomes more expensive. It was 10 yuan to the
dollar, now maybe it is 8 yuan to dollar. So this is where we
get to eventually. Because of this supply demand
imbalance right over here. 8 yuan to a dollar. Now, what’s the reality
over here? This guy over here needs to sell
his dolls for 10 yuan, which before was the
equivalent of $1. But now how much is he going
to sell his yuan for? He needs to sell for 10 yuan. That’s 8 yuan per dollar. So let’s think about how much
his dolls cost. So his dolls, in the U.S., now that the
yuan has appreciated, they were 10 yuan. And then, times– we have
$1 for every 8 yuan. So this is going to be equal
to the yuans cancel out. This is really just dimensional
analysis you might have learned in chemistry. So 10 over 8 is what? That’s 1 and 1/4. This is $1.25. Notice the price of his dolls
went up in the United States in terms of dollars. And let’s think about what
happened to the cola manufacturer right over here. So his costs, or the price he
needs to sell them for are $1. And now what’s the
exchange rate? Let me write it the other way,
because I need to cancel out the dollars. We have 8 yuan for every $1. Dollars cancel out. 8 times 1. His selling price in China
will now be 8 yuan. So notice, neither of these
people changed their prices in terms of their home currency. No change in price at all. But because of the currency
movements, because the yuan became more expensive, the
Chinese manufacturer’s goods are now more expensive
in dollars. And the American manufacturer’s
goods are now less expensive in yuan. So what’s going to happen? What’s going to happen here? At $1, there was a demand
for 100 dolls in the United States. But now that the price has gone
up to $1.25, there will only be demand at this higher
price for 50 dolls in the United States. And let’s say this
guy over here. Before, there was demand for 50
cans of his cola in China because it was 10 yuan. But now, the price
has gone down. So, now, you can imagine that
there is demand, or actually I should say there’s demand
for 50 dolls. And, now, because this guy’s
price has gone down, instead of demand for 50 cans, maybe
there’s demand for– and I’ll just make up a number–
80 cans. Maybe there’s now demand
for 80 cans. So what just happened to
the trade imbalance? Before, in terms of either
currency, we were buying more dolls, if you think about from
the U.S. perspective, and shipping fewer cola. But now, we’re buying fewer
dolls, because it’s now more expensive in the
United States. And we’re shipping more cola. So I don’t even know how
this math works. I’m going to let you
figure that out. But as one currency gets more
and more expensive, those exports, the demand for those
exports from those countries, are going to go down, like
we saw with these dolls. And on the other side, as the
other currency gets cheaper and cheaper and cheaper,
the demand for those exports will go up. Because, in other currencies,
it will look cheaper. And, eventually, you
should have some type of trade balance.

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42 Comments

  • Reply GenghisVern October 25, 2010 at 4:13 pm

    Now my brain hurts 🙂

  • Reply norwayte October 25, 2010 at 4:35 pm

    …or maybe one currency world wide without speculation… 🙂

  • Reply Ryan Racca October 25, 2010 at 4:46 pm

    It's quite disturbing that the United States was accidentally spelled as United Slates.

    Subliminal message if you still didn't get it…

  • Reply Khan Academy October 25, 2010 at 4:47 pm

    @norwayte You would then have to have one global monetary policy which is tough since every nation would be experiencing different levels of growth, inflation, debt, unemployment etc. The EU is already facing this problem: Germany's situation is very different than Greece's but they have to have the same monetary policy. It would be even more extreme on a global basis.

  • Reply meanmanturbo October 25, 2010 at 4:48 pm

    So, any input on export based economies wanting to keep exchange rates of their currencies low? China artificially keeping the exchange rate low springs to mind. Great video as always!

  • Reply noxure October 25, 2010 at 5:50 pm

    @khanacademy But two different states in the US can also have vastly different economic situations (ie, north and south) and there is an even more enormous gap between rural China and metropolises like Beijing or Shanghai. Yet, the US dollar and the Yuan are both considered as strong currencies.

  • Reply boeing747200lr October 25, 2010 at 6:05 pm

    Thank you, Sal!!

  • Reply Khan Academy October 25, 2010 at 6:07 pm

    @noxure That's true, although the economic difference between even the poorest US state and, say, Zimbabwe or Afghanistan is FAR bigger than the difference between, say, West Virginia or Mississippi and Connecticut. There is definitely a large wealth disparity between rural and urban China, but the fiscal situation is the same (same central governemtn). The main point, however, is that if you really want one currency, you need one monetary policy which really means one government.

  • Reply Khan Academy October 25, 2010 at 6:10 pm

    @noxure I'll add that the Europeans are facing difficulties because some governments like Greece have run up so much debt that they are insolvent while others are much more responsible. Very difficult to address the needs of Germany at the same time as Greece (especially when there isn't a consistent fiscal policy).

  • Reply norwayte October 25, 2010 at 6:30 pm

    @khanacademy … Right, Sal, problem area: differences (growth, debt, …) And now? That's it? "Curing/Healing" own, self-made problems (…USA) for instance with currency "wars"?! As seen in the past? Outsource and/or prolongate own problems to other nations on their backs…and one favorite way to do it is currency-juggling? And other nations alike…
    One missing thing with the Euro: a really combined general policy.
    Keep on going…maybe we all get some ideas while watching your videos.

  • Reply warrenlaurde October 27, 2010 at 10:09 pm

    @khanacademy There HAS been a global monetary policy for the past 50 years: USD enforced by IMF/WB debt slavery, backed by control of ME oil by the MIC (the only real asset anyway). It's ending, panem et circenses notwithstanding. But that's another vid 😀

    GREAT job explaining an abstruse topic!

  • Reply Amath Mbaye February 27, 2011 at 9:51 am

    @khanacademy all though i agree with your statements, one world currency doesn't necessary require one government it just requires one policy maker, in the case of Europe for example the EU makes polices for all nations which has to be accepted by members of the EU, however, the nation itself is self governing in the sense that areas in which the EU can make policies are limited by the interest of members rather then individual national interest,

  • Reply Amath Mbaye February 27, 2011 at 9:54 am

    @khanacademy {just continuing my bickering lol} unification of all nations by making policy making a matter of international significant rather then the current state of things can be hugely beneficial in removing issues mainly cause by segregation of nations through policy and border control, although there certainly are issues with this way of doing things.

  • Reply Jotto999 March 10, 2011 at 1:24 am

    I'm getting into Forex, currently practicing on a demo account, and whenever I reach a target profit on that, I'll be starting with small amounts of real money, and I'll see how it goes.

    Thank you very much for these videos, very helpful.

  • Reply negochristian1 May 6, 2011 at 5:58 pm

    You guys rly think Khan has time to answer all your questions ? xD Guys above are lucky, in a few years they will be able to say that they got their questions answered by Khan…It will be like now someone saying Bill Gates used to reply their messages.

    Thumb Khan up towards the Nobel Prize !

  • Reply Richard Chen July 16, 2011 at 4:04 am

    @vickiormindyb how did Sal offend your friend ?

  • Reply FoodTech41 August 5, 2011 at 3:08 am

    In reality, does the China pay the US in Yuan? My intuition told me they would change their Yuan into US dollar and pay the US. If my thought was true, there would be more demand for the US dollars and things would have gone the other way around. I am really bad at Econ and Math, so sorry if I'm wrong. 😛

  • Reply andrew charman October 30, 2011 at 6:27 pm

    @norwayte
    boooooooooooooooooooooooooooo

    try to close the markets to the public, and I will protest with fire and pitchforks

  • Reply Justin Jennings December 5, 2011 at 2:02 am

    who taught you how to write?
    walt disney? XD

  • Reply styles7887 February 5, 2012 at 5:31 pm

    We need to produce the dolls and not buy them,if its getting to the point of higher and higher unemployment and lower demand for the dollar.That would bring jobs ,new buildings and investment opportunities;people will have more dollars and bonds in the u.s currency ,which means the demand will go up.

  • Reply Alejandro Andrés Hernández April 19, 2012 at 5:00 am

    You're right, but since the US would also pay China in Yuan (Not dollars) that transaction would have gone the other way around too. Your reasoning is probably correct, but the way he explains it makes it easier to understand and reaches the same basic conclusion (in a mathematic and economic way)

  • Reply einerus June 26, 2012 at 1:58 am

    Constant repeating of every sentence makes it sooo anoying to watch this and listen.

    Constant … repeating of … every sentence makes …. it sooo …. anoying to watch …. this and … listen…..

  • Reply theHDLify July 29, 2012 at 3:47 am

    Does this mean that if a particular country has more exports than imports its currency becomes stronger?

  • Reply ivan date September 16, 2012 at 12:48 pm

    can you build such trade model goes if currency was decided fix all the time ?? what disaster will come?

  • Reply hemant manwani October 14, 2012 at 12:12 pm

    it simply make sense…thanks Mr. khan…..I.O.U 🙂

  • Reply trylikeafool January 13, 2013 at 8:56 pm

    Good explanation, but please stop repeating every other word. I wanted to drill a hole in my skull 5 minutes in.

  • Reply Daniel Barbeau March 15, 2013 at 4:17 am

    dont write out EVERYTHING that you say it makes the video too long

  • Reply Daniel Barbeau March 15, 2013 at 4:17 am

    and you could be a bit less colloquial maybe?

  • Reply Azhar S June 1, 2013 at 10:14 pm

    Strong Pound Imports Cheaper Exports Dear (SPICED) visa versa

  • Reply Peter Clark July 27, 2013 at 3:12 am

    Great explanation, thanks!

  • Reply Vicki Bee November 20, 2013 at 5:25 am

    He even knows all the three-letter codes: KRW, KPW, CNY. He knows every last one of them.
    He's always making me feel stupid. 🙂 Silly man. 😛

  • Reply Uncle Spoon September 21, 2015 at 3:42 am

    get to the point…too much speaking

  • Reply Erick Bzovi July 25, 2016 at 2:45 am

    Thanks for posting

  • Reply Tim Garland September 27, 2016 at 10:19 am

    Great info. Thanks!

  • Reply Jake Riccio December 10, 2016 at 7:25 pm

    so, we don't need tariffs after all.

  • Reply Ebrahim Mamsa March 29, 2017 at 6:22 am

    Great video. This video explains simply the currency effect on trade. As a forex trader, we know that, currency can be trade worldwide. But yes, there are some currencies which are valuable for every country and popular among all over the world, which are called major currencies. Basically forex people trades most of time with major currencies. I am trading currency with ECNCAPITAL. For me this one is the reliable forex broker.

  • Reply Manaickiller Draciaux April 11, 2017 at 1:30 pm

    When they both Exported the Ships Fought to the death and claimed the treasure AAAARG Pirates

  • Reply Ever StanDinG October 6, 2017 at 7:01 am

    I liked the video but sorry this last part is wrong, this is not how the trade balance happen after the currency exchange rate changes, what happens is that the chinese guy either continue to sell dolls for $1 and accept that he is earning less or he will make the price of dolls go up to 1.25 like you said but this will result in him selling fewer dolls & eventually earning less too, as for the american cola guy he will continue selling cola for 10 yuan and earn more.. and as a collective result of that the american will have alot of yuans he want to sell for dollars and the chinese will have less amount of dollars he wants to sell for yuans, which will result in dollar price going up and the exchange rate will balance itself

  • Reply John Luttrell July 12, 2018 at 1:43 am

    The comments section is loaded with idiots…he is explaining this as if you’ve never heard it before…he’s doing this in real time…it’s not rehearsed….watch his videos and you will start to see why he is so effective . Too many teachers speak with students assumed knowledge . Sal is doing fantastic

  • Reply الزين ولد المختار October 19, 2018 at 6:11 pm

    شكرا = thank you

  • Reply Oj D September 10, 2019 at 8:12 am

    Great explanation on how one country's currency weakens or vice versa. Terrific example!

  • Reply Ray Blevins December 11, 2019 at 9:01 pm

    Except China has pegged ¥ to the $. They manipulate the value of the ¥ by adding more to the market.

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