So let's say right now, if I were to just go on some website — And this is not the actual exchange rate right now. But let's say, right now, the quoted exchange rate is 10 Yuan per U.S. dollar. 10 Yuan is equal to 1 US dollar. And every time I say "dollar" in this video, I'm referring to the US dollar. ( — is equal to 1 US dollar.) I think this makes sense to a lot of people. If I have one dollar, [and] I want to convert it to Yuan, I get 10 of them [Yuan]. If I have 10 Yuan and I want to convert [them] to dollars, someone is going to give me a dollar for [them]. Now let's imagine a situation — (And in the next few videos, I'll construst actual trade imbalances where this would actually happen.) But let's say we live in a reality where there are 1,000 — — so let's say someone has 1,000 Yuan. So let's say that this person right here has 1,000 Yuan — and wants to convert to dollars. Now, let's say, on this side — And if we just superficially looked at this 1000 Yuan — and looked at the quoted rate,we'd say "Hey, that 1000 Yuan — you divide, you get 10 Yuan/dollar, so that should be a hundred dollars, at the quoted rate." Let's say you have two other actors over here. And obvioulsy, this market involves many, many more than just three people.
But this will help us simplify or at least understand, how these exchange rates would work. Let's say that this person right here — let's say that this person right here with the mustache — let's say that this person right over there, and maybe a hat as well — Let's say that he has 50 dollars — he has 100 dollars that he needs to convert to Yuan. Maybe he wants to buy some Chinese goods. Maybe he is a Chinese factory owner who sold his goods in the US for 100 dollars. And now he needs to convert it back to Yuan to pay his employees or pay his own mortgage, or who knows what. And let's say that there's another person — Let's say there's another character over here. And let's say that she also she also has a hundred that needs to be converted into Yuan. So, net-net, what's happening here? What's the total demand to convert Yuan into dollars, and dollars into Yuan? Well, if you look at the whole market, you have $200 that need to be converted into Yuan. So let me write this down.
We have a situation where 200 dollars need to be converted into Yuan. And then, on the other side of that transaction, we have 1000 Yuan that need to be converted into dollars. So, now we have 1,000 Yuan need to be converted into dollars. And for simplicity, these are the only actors. They are representing the entire market. Although, as we know, in currency markets especially, there are thousands — or even millions — of actors actively participating in them. So what's going to happen? All of these people might just go on the Internet, and look up the current exchange rate or the last exchange that occurred — and [say] "Hey, you know what, me over here, this $100, I should be able to convert into a 1000 Yuan." But she also says "I should be able to convert this 100 dollars into a thousand Yuan." So they collectively think that that 200 dollars can be converted into 2000 Yuan. So I'll put this in question marks. So will they be able to convert this into 2000 Yuan? And on this person over here, he's saying, "Well, just at the current exchange rate maybe I'll be able to get for my thousand yuan — maybe I'll get 100 dollars." But everyone wants to maximize the amount of the other currency they get — for obvious reasons.
They want to maximize the amount of money they get. Now. Will these 2 people be able to convert their money into 2000 Yuan? Remember. What I said is that this is the entire market. It's a huge [over]simplification. But there is this imbalance here: more dollars into Yuan than Yuan into dollars. Now, they won't be able to convert into 2,000 Yuan, because there's only 1,000 Yuan that wants to be traded. (There's only 1,000 Yuan that wants to be traded.) So you could imagine, this guy over here, maybe he wants to do it slowly, just to kind of see what the market is like. So, let's say, at first he puts 10 Yuan up — essentially for bid. You could do it either way. You could say that maybe one of these people put a dollar up for bid. And this guy is bidding on that dollar in terms of Yuan. Or this guy is putting Yuan up for bid. And these guys are going to bid on it in terms of dollars. Either one. And that's why it's sometimes confusing with currency. It's because you are buying another currency. But since this guy['s currency] is more in demand.
To simplify things, I'll make him the person that's kind of able to create an auction-type situation — which really is what the markets are trying to do, so that you can equalize supply and demand. So he might put out — he might initially say: "Hey, you know what? I want to convert —" He has 100 Yuan, and he wants to convert it. So he says, "You know what? I'm willing to sell 100 Yuan for $10." So, let's say he sells 100 Yuan for 10 dollars. So he sells 100 — or offers, I should say — offers to sell 100 Yuan for 10 dollars. She just thinks that's a fair offer price, right over there. And that's this guy over here, this guy actually converting yuan into dollars. Well, what's going to happen? Well, one of these people are just going to jump at that. They say, "Oh. You know what? I think that's a fair price." And so, let's say, this woman right over here takes it. Actually both of them, maybe, saw that offer to sell 100 Yuan for 10 dollars. And they both tried to click their mouse, or however they're trying to make the transaction [happen].
But let's say she clicks her mouse a little faster, and she gets the transaction. So let's say — Let's call this Person B, and this is Person A, and this is Person C. So Person B accepts. So two things happened just then. One is, Person C says, "Well, that was pretty fast." "Someone was very willing to take it for 10 yuan per US dollar." And then this guy goes, "Oh my! I need to convert my money into Yuan; but I wasn't able to." "Someone else beat me to the punch!" So this guy over here is like, "Hey, maybe people are willing to give me more dollars per yuan." So, let's say that this guy right over here — this guy in orange — he then offers to sell. Let's say he wants to sell 90 yuan for 10 dollars. Notice. The price of the Yuan has now gone up — or the price of the dollar has now gone down. Either one, those are symmetric statements. They mean the exact same thing. So, all of a sudden, this person has a lot of dollars he needs to convert into Yuan. So he accepts really fast. So, person A accepts. And I'm doing a huge oversimplification. But it gives you the general idea to show you that this really is a market. So Person A accepts.
All of a sudden we have a new quoted exchange rate. All of a sudden we have an exchange rate of — What is this? — 9 Yuan. So we have [a] new quoted rate — or the transaction happens at 9 Yuan per dollar. Now, what's happening? And I think you see the dynamic that is going to happen. There are more dollars that need to be converted into Yuan than Yuan that need to be converted into dollars So, this guy — as he sees that there's a lot of demand to get his 1000 Yuan — he's going to keep offering fewer and fewer Yuan per dollar. Or, these guys are going to start accepting fewer and fewer Yuan for each of their dollars. So, as this happens, the price of the Yuan will go up. Notice: the price of Yuan went up here. It was 10 Yuan per dollar; now it is 9 Yuan per dollar. Or you can say that the price of the dollar has gone down. And this will just keep happening until all of them are able to get rid of their currency.
It's actually dependent. There's no mathematical formula to say what the clearing price is. It's actually dependent on how badly each of these people are willing to transact and really how good they are at gaming each other. But the general results here — and this is what I really want you to get from this video is that because there's no law in a market exchange rate mechanism that says, "This has to be the exchange rate" — we'll explore how you can peg it in the future but there's nothing that says that this has to always be the case. If there's more demand for Yuan than dollars — as we see in this example — the price of the dollar will go down. I'll do this in a — Price of dollar will go down. And then — which is the exact same thing — which means the exact same thing as, "The price of yuan will go up —" I really want you to internalize this. — will go up in terms of dollars. [The] price of dollars, in terms of Yuan, will go down. And this is the crux of foreign exchange. If you can, at least, internalize these ideas and understand that there really is this market out here, based on the supply and demand of Yuan. Over here, the demand for Yuan is exceeding its supply so price will go up, and — Or you can do it the other way. The demand for dollars is below its supply. So, the price will go down. Anyway, I'll let you think about that for a little bit. And in the next video, we're going to apply this concept to see how this freely floating exchange rate can help equalize — or should help equalize — trade imbalances in an ideal world.
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