Wednesday, October 29, 2003

Some basic fundas of eco:
"A final reason why America should welcome and not bash China is that Chinese money is helping to prop up America's economy. To prevent its currency rising, the Chinese central bank has bought huge amounts of American Treasury bonds and mortgage securities (see chart). Its willingness to provide cheap credit to the American government to finance tax cuts and, indirectly, to home buyers has thus underpinned America's recovery. If China dumped those dollars, American bond yields would rise further, halting the mortgage-finance boom that has buoyed consumer spending."
Why?
A central bank buys dollars (and puts in more supply of the domestic currency) whenever it feels that the domestic currency would appreciate (which would in turn affect exports). ( So supply of domestic currency is more than the demand and therefore price of domestic currency would come down - which means that the appreciating currency has been arrested). So this it does by open market operations - buying bonds e.g. American Treasury bonds. This means that the country would actually fund the foreign government with money to finance its expenditure. But suppose the country dumps all its dollars/bonds, then the bond prices would come down (and the yield rate would increase) which means all the rates pegged to the yield would go up -> which means that the interest rates can go up which can affect economic recovery (esp on the demand side).

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