Understanding Yuan - USD relationship

Beginner Questions
1

Been reading about Treasury yields etc and getting my head round fundamentals, I’ve got a Q I can’t figure out. Would be very grateful for enlightenment!

  1. I get that Treasury yields and Treasury prices move in opposite directions
  2. I gather China would generally prefer a strong USD as it benefits China’s export market
  3. China is the largest holder of US Treasuries and regularly buys them up

but what I don’t get is how that doesn’t WEAKEN USD?

  1. Increased demand for US Treasuries (China buying lots)
  2. Price goes up
  3. Yield conversely goes down
  4. USD typically follows the yield, e.g. rising yield is bullish for USD, dropping yield is bearish for USD (interest rate differentials, etc)

So how does that policy keep USD strong against the Yuan? It seems to me to do the exact opposite?

2

China, through the PBOC, controls the amount of yuan circulating in the market.

When Chinese manufacturers sell goods to the US, they are paid in US dollars.

But Chinese manufacturers can’t pay their workers and expenses in US dollars…since they’re in China…which means they now need to SELL their newly acquired dollars and BUY yuan.

Doing this would would strengthen yuan though (due to higher demand) which China doesn’t want because their exports would become more expensive.

More expensive exports would mean being less competitive in the global markets. Which would mean less export sales. Which would mean massive job losses. Which would eventually mean social unrest. Then maybe riots and crazy mayhem.

So what do they do?

The PBOC buys the dollars from them and gives them yuan.

Where does PBOC come up with the yuan to buy the dollars from the manufacturers?

Using central bank magic. They simply type it into existence with keystrokes.

This artificially keeps the yuan weak. Which benefits exporting companies.

Now the PBOC doesn’t like holding a boatload of cash, it generates no yield, so it needs to “park” it somewhere safe…so they use the dollars to buy US government bonds.

3

China’s purchase of USD is just one reason affecting the yield. The most important reason for the same is the interest rate set by Fed who is in ‘tightening mode’ to ward-off the threat of inflation. So, if Fed raises rates by 25 bps and yields come down by 10 bps due to huge buying by China, there is still 15 bps gain in yield.