I’ve looked and looked and I just can’t find any information on how this works. I’m having trouble understanding what goes on behind the scenes when a country’s government borrows money from another country’s government; for example, the Chinese funding our (US) deficit spending. Obviously Americans can’t spend Yuan domestically. So, does the Chinese government first buy dollars with Yuan and then buy US bonds with the dollars they just bought? How does the US money supply expand by this? Is the Fed printing new money at some point?
This concept is easier to understand on a commodity standard I think. If we all use gold, then another country sends us some of their gold and we add it to our reserves. Easy. But going back to the Chinese, do they send us Yuan, we put it in reserves, then we print new money, give them the money, then they buy bonds? Which takes me to my next question…why borrow? Why not just print?
America has a trade deficit with China. Americans buy more from China than China buy from USA. Therefore, our US dollars end up in the hands of Chinese entrepreneurs / exporters and they don’t exchange it back with us for our goods. Our US dollars pile up in Chinese bank accounts. If Chinese took our US dollars and exchanged it for existing Yuan then that would force the value of the Yuan up and the value of the dollar down. The exchange rate would go up on the Yuan and Chinese products would become more expensive for Americans. To prevent this, the Chinese central bank prints more Yuan to give banks in order to exchange new Yuan for the entrepreneur’s US dollars. This is how USA exports its inflation to other countries. They print more of their money to buy our money they get from us. The Central bank of China therefore gets all these US dollars in its account. It then can recycle these US dollars back into the US economy by giving them back to the US government in exchange for US treasuries. The Chinese central bank therefore buys and holds US government IOU’s while the US gov’t gets their dollars back.
Similarly, the Chinese not only buy US Treasuries but other debt securities from Wall Street, like credit card debt and mortgages. They give back our dollars to us so we can continue to accumulate more debt while buying their stuff.
For us to pay them back (their wealth they exchanged with us for our dollars) we have to produce other goods or services that they can buy back from us. The value of the fiat dollar is only based on what products or services it can buy. Americans therefore need to actually produce things so Asians can exchange their claim to US dollars (via their US Treasuries promising to pay them US dollars) to get products or services (real wealth) in return for the wealth they have loaned us (the products we bought with their loan). The Federal Reserve however just prints more money to buy some (most?) of the US Treasuries and other debts from the Asians. They call it Quantitative Easing. It’s increasing the number of dollars in the economy, not increasing the number of goods or services that Asians or any other holder of dollars can exchange their dollars for. It just results in rising dollar prices for goods. Raw inflation.
The magic of this scheme has been ongoing since the Bretton Woods agreement in 1944 made the US dollar the reserve currency for every other country that trades with the USA (that’s like everyone). On the gold standard, foreign central banks created money based on their gold reserve. After Bretton Woods these central banks created money based on their reserve of US dollars or US treasuries. The beauty of Bretton Woods was that it let America rip all the other countries off since we broke the gold standard in the late 1960’s and then officially in the 1971. No other country can borrow from other countries like the USA can from others, because their dollars are not reserve currency dollars. Only America can borrow a money (US dollars) while we have a printing press that can create those dollars to pay back its creditors, and get away with it. Other countries (like Zimbabwe or Weimar Germany) have tried to do this but it ends up in Hyperinflation.
Sorry, I didn’t realized anyone responded to my post (seven months ago). Thank you for your detailed answer. Can you explain this more, “If Chinese took our US dollars and exchanged it for existing Yuan then that would force the value of the Yuan up and the value of the dollar down”. So a US buyer gives a Chinese seller US dollars. The US dollars are deposited in a Chinese bank, but the seller doesn’t necessary want dollars, they want Yuan. So instead of trading the dollars for Yuan already in the Chinese economy, the Chinese central bank prints money to buy the dollars. This gives the non-central bank new Yuan to cover the new US dollars. Is this right?
Is another way of saying this, because China is such a big trade partner, and the US prints/printed so much money, that if China didn’t print money also to “keep up”, it’s not that their currency would rise per se, rather the US dollar would show it’s weakness in depreciation against the Yuan. If that’s true though, then really, don’t all currencies have to make sure they print enough to keep the dollar afloat?