Beginning in July 2005, the Chinese government officially unpegged the RMB from the dollar, and, since then, the currency has appreciated by about 6%. Chinese policymakers seem likely to allow this process of gradual RMB appreciation to continue, so long as it is slow and orderly. Few people, however, believe that even a more substantial RMB appreciation would have much effect on China's overall trade balance. F or one thing, to the extent that China imports many components used in producing its export goods, an appreciation lowers the cost of those imports, offsetting somewhat the effect on export prices. For another, demand for many Chinese exports tends to be fairly strong, regardless of price, which implies a limited trade response to an appreciation. Most observers do not see China's trade surplus coming down until it ramps up government spending and domestic consumption, increasing its own demand for foreign imports.
To exert some control on slow and orderly movements in the RMB, the PBOC intervenes in the foreign exchange market, buying dollars with RMB that it issues. This intervention has resulted in the PBOC's accumulation of over $1 trillion in foreign reserve assets. Moreover, such intervention also swells the domestic supply of bank reserves. Therefore, to avoid inflation, the PBOC must offset the associated liquidity increase by sterilizing reserve inflows. It has accomplished this by issuing low-yield PBOC bills in open market operations and by progressively raising the reserve requirements of domestic banks. However, the policy of forcing low-yield PBOC bills on the banking sector works at cross-purposes with banking sector reforms, which are ultimately aimed at creating a banking sector that operates on a sound commercial basis.