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So, as Treasury Secretary Paulson talks to the Chinese government about the Yuan (pronounced zhew-on'), there are some dire consequences for U.S. mortgage rates.

Paulson's concern is that the Chinese currency is too weak versus the U.S. dollar which keeps Chinese goods cheap for Americans.

The connection makes sense if you look at it in terms of Supply versus Demand. 

Cheaper goods means that the U.S. will continue to buy Chinese goods, directing important dollars away from the U.S. economy and into the China economy.

To force the issue, the U.S. government is talking about imposing a 27.5% tariff to "encourage the right behaviors".

So, why should you care about this as a homeowner or as a mortgage shopper? 

Because the only way that the Yuan will increase in value versus the U.S. dollar is if the Chinese buy fewer of our bonds, including those that are mortgage-backed.

Right now, when Americans spend money in China, the government there takes those dollars and buy U.S.-demonimated bonds.  Considering the sheer size of China's economy, that translates into a lot of demand for U.S. bonds.

If the Chinese stop buying bonds, the demand for the bonds will drop and that will increase the relative supply.  As any of our friends in sales would attest, the best way to sell a product in an over-supplied market is to drop the price.

When bond prices drop, interest rates go up.

Source
Chinese Yuan
Wikipedia
http://en.wikipedia.org/wiki/Chinese_yuan

Paulson, on eve of China visit, sees no quick fix
Glenn Somerville
Reuters.com, September 18, 2006, 7:26 A.M.
http://today.reuters.com/news/articlebusiness.aspx?type=ousiv&storyID=2006-09-18T112651Z_01_SP239401_RTRIDST_0_BUSINESSPRO-ECONOMY-DOLLAR-DC.XML&from=business

Dan Green is an active loan officer. Email or call 513-443-2020. Dan is on Twitter at @mortgagereports.