I have some problems figuring about what happens with a countrys inflation and value of their currency when theyr are trying to finance debt by issuing T-bonds. E.g. America is issuing T-bonds and the Central Bank of China buys them. My theory is that, the Central bank of China is pringting money, which they use to demand US $. China though wont see rising consumer prices as there was never more Yuan available in China. But their currency will be weakened relative to the dollar, as the supply of Yuan and the demand of the dollar increased.
My theory is probably wrong, but I find it very difficult to grasp what really happens. I would appreciate if someone could explaine me.
It depends what is the source of yuans... If it's government tax revenues, then buying dollars is not inflationary. However, this stuff is usually done by central bank, by buying foreign currency in FX exchange using printed money. So it is inflationary, and China is experiencing large growth of monetary aggregates. China wants this to be inflationary to some extent (to push the FX value of yuan down against other currencies). However, they still have to mantain CPI inflation at some range, so they have to sterilise part of the new yuans in circulation. This can be done by changeing bank reserves requirements or issuing special central bank bills.
China inflating fast:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aLyeIFnC8X1U&refer=home
Thx for the answer. Btw what is a special central bank bill?
It's a financial instrument that has yield (interest), however money received by sale is kept in the CB reserve account. Money is not released to banks or governement in any way.
When normal bills are issued (T-bills), government puts that money into normal bank account and spends that money, adding to the bank's cash reserves. No money is effectively withdrawn from circulation (just moved from private investors account to government account)