Maybe I'm making the mistake of thinking this actually means something mathematically, but when I see a chart, that's what I assume.
There's an X axis and a Y axis, which are labeled "Dollars" and "Yuan per dollar", respectively. Then there are two lines, one labeled "Supply of dollars", which is going up, and one labeled "Demand for dollars", which is going down. Let's ignore that bit in the middle for the moment, because without understanding these lines I can't hope to understand that one. I'd think that both of these lines represent a relationship between the supply of dollars and the price of a yuan in dollars or a dollar in yuans. Wouldn't you? Yet one line seems to have nothing to do with that, and the other is just labeled "Supply of dollars", which is what's on the X axis.
I'm not picking on Krugman here. Nearly every economist does this. I just have no idea why.
As for that line in the middle, here's what Krugman had to say about it:
The more depreciated China’s exchange rate — the higher the price of the dollar in yuan* — the more dollars China earns from exports, and the fewer dollars it spends on imports. (Capital flows complicate the story a bit, but don’t change it in any fundamental way). By keeping its curren[cy] artificially weak — a higher price of dollars in terms of yuan — China generates a dollar surplus; this means that the Chinese government has to buy up the excess dollars. There’s nothing arcane about it.
Which I pretty much get despite the aid of this chart. China is keeping its currency devalued, so that it can sell more of its product abroad. Essentially, it's a modern form of mercantilism, as Krugman explained earlier. That policy helps make their products less costly than ours, and makes the debt we owe them, which is in dollars, more valuable.
How do they implement that policy? They do it by buying up dollars, sometimes as T-bills or other U.S. government debt. It's like what happens when a ball game or a concert sells out - the remaining tickets become more valuable.
Trust me, just think about that for a moment and it will make more sense than the chart.
UPDATE: Added that paragraph about how China makes the dollar stronger. While reading the Wikipedia entry on mercantilism, I ran across this quote from 2007:
By accident or design, China has embraced export-led economic growth. The centerpiece is a wildly undervalued exchange rate. Economist Morris Goldstein of the Peterson Institute thinks the renminbi [Chinese money] is 40 percent cheaper than it should be. The resulting competitive advantage props up exports, production and jobs. Since 2001, China's surplus on its current account—the broadest measure of its trade flows—has jumped from $17 billion to $239 billion. As a share of GDP, it's zoomed from 1.3 percent to 9.1 percent. These figures include both Chinese firms and multinational companies doing business in China.
China's Wrong Turn on Trade
It's by Robert J. Samuelson, who is a journalist who specializes in economic issues. A later paragraph sounds like as much of a warning for the U.S. as it is for China:
Even Chinese officials favor higher local demand. But either they can't or won't stimulate it. Personal consumption spending is a meager 38 percent of GDP; that's half the U.S. rate of 70 percent. People save at astonishingly high levels partly because they're scared of emergencies. The social safety net is skimpy. Health insurance is modest: out-of-pocket spending covers half of medical costs, reports economist Nicholas Lardy of the Peterson Institute. There's no universal Social Security, and only 17 percent of workers have pensions. A mere 14 percent are covered by unemployment insurance.
China's Wrong Turn on Trade
As Ian Welsh noted a few months ago, China has begun to address this shortfall by announcing a plan for universal health care. Given our own misadventures recently, this is one more reason to believe that the U.S. is headed for second class economic status. In fact, the current lack of consumer spending is just the sort of thing you'd expect when a nation's people can no longer trust their government to maintain a safety net.
This is yet another reason why the current health care bill status, and the Obama Administration's announced intention to freeze discretionary spending, and scale back Social Security and Medicare are, for lack of a better phrase, fucking insane. Consumer confidence is low, and isn't going to get better as long as we know that one illness, or a lost job, may mean the end of our lives if we're not prepared.
People who wonder why I'm so down on the Obama Administration ought to consider the fact that, from both an economic and social point of view, they always seem to be doing exactly the wrong thing, and acting as though they have no choice in the matter.