Julio wrote:
And let me add quickly that sterilization is, of course, more than building up reserves. You have to offset the building up of reserves (for which you pay in high-power local currency thus expanding "nominal" M) by floating debt domestically or otherwise tightening credit.
=============================== Right. To maintain the exchange rate, the People's Bank of China buys dollars deposited in the banks by exporters and foreign investors, and sterilizes the operation to prevent inflation by mopping up the excess yuan with government bonds. As for the hot money problem alluded to by Raghu, China is gradually loosening its currency controls, but as far as I know, it's still illegal to sell the currency for dollars in the open market. These transactions occur only through state-approved banks, and only for trade and foreign investment purposes or to allow Chinese citizens to take a limited amount of yuan with them when they travel abroad. I doubt if there'd be much of a black market in USD's since the yuan is expected to remain steady or appreciate against the dollar.
