How Does China Manage Its Money Supply? (2024)

Almost all countries in the world control their respective money supplies through their central banks.The Federal Reserve Bank (FRB) controls the money supply in the United States,and thePeoples' Bank of China (PBOC) controls the money supply in China.

China is the second-largest and fourth fastest-growing economy inthe world, as of April 2022. The nationhas a unique socialist open-market economy. China's government retains tightcontrol but remains open to free-market forces.As a manufacturing and export-driven economythat receivestremendous amounts offorexcapital for its exports,the Chinese currencyforex rates also impact the country'smoney supply.

This article discusses the main methods used by China to control its money supply and forex rates.

Understanding Money Supply

Money supply, or money stock, is thetotal amount of money in circulation or in existence in a country at a given time. Money supply impacts price levels, capital availability,inflation, and the overall business and economic cycle of a country.

A high velocity of circulationleads to more spending power and lower interest rates, which increases the amount of capital available for investments, businesses, and spending. The reverse occurs with a low velocity of money supply.

Government authorities closely observe money supply and take necessary actions suitable for the overall economyor for selected sectors.China's money supply policiesdiffer from conventional methods used by other countries because of the country's unique economic system.

The Traditional Chinese Economy

Asa manufacturing and export-driven economy, China runs atrade surplus. It sells more to the world than it purchases. Chinese exporters receiveU.S. dollars (USD) for their exportsbut mustpay for local expenses and wages in local currency, the Chineseyuan or renminbi (RMB). Due to the huge supply of U.S. dollarsand the demand for yuan, the rate of yuan can rise against the U.S. dollar.

If that happens, Chinese exports become costlier and lose their competitive price advantage in the international market.This is problematicfor the Chinese economy,potentially resulting in lower or no sales of manufactured goods, widespread unemployment, and economic stagnation. The Chinese central bank PBOC intervenes to avoidthis situation, keeping the exchange rates lower through artificial measures.

ChangesintheLast Decade

The Chinese money supply in recent times hasshown consistent growth. Along with the money supply, the Chinese gross domestic product (GDP) has also increased in similar proportions.

The relationship between China'scurrency and the economy is interesting because its export-dependent economic system works differently fromthat of other countries. From 2010 to 2020, major reforms spearheaded by the Chinese government have increased China's market orientation and have opened up the Chinese economy.

The periodhas seen themonetization of a variety of resourcesand their availability to the open market, which has attracted large-scale foreign investment. The resources includemanufactured goods, infrastructure, technology,and natural resources,as well as human capital and labor. There has been an increase in demand for the Chinese currency, which stimulated commercial bank lendingand finally increased the money supply. The money supply has risensignificantly over the last 10years. During high and consistent growth rates,China managed the increasingmoney supply effectivelywhile keeping the currency rates stable.

How China Controls Its Money Supply

China uses a variety of methods to manage its money supply. Here are theprincipal methods used.

Controlling Forex Rates

One major task of the Chinese central bank, the PBOC, is to absorb the large inflows of foreign capitalfromChina’s trade surplus. The PBOCpurchasesforeign currency fromexportersand issues that currency in local yuan currency. The PBOC is free to publish any amount of local currencyand have itexchanged for forex.

This publishing of local currency notesensures that forex rates remain fixedor in a tight range.Itensures that Chinese exports remaincheaper,and China maintains its edge asa manufacturing, export-oriented economy. Above all, Chinatightly controls the foreign money coming into the country, which impacts its money supply.

Sterilization

China implements different sterilization actions, which refers to a monetary action the PBOC takes to curb the impact on the money supply from the constant inflows and outflows of capital. The PBOC's actions, however, can createsome adverse consequences.

The bank increases the supply of local currency in domestic markets, which increases the chance of high inflation. To cut back on excess money supply, the PBOC sells the requiredamount of domestic currency bonds, which takes away the excess cash from open markets. The PBOCalso buys domestic currency bonds to infuse cash in the marketswhen needed.

Printing Currency

Printing domestic currency is another measure applied by China. The PBOC can print yuan as needed, althoughthis can lead to high inflation. However, China has tight state-dominated controls on its economy, which enables it to control inflation differentlycompared toother countries. In China, changes are made to subsidies and other price control measures to check inflation.

The Reserve Ratio

Commercial banks are required to keep a percentage of their total deposit amount with the central bank of the country, which is known as thereserve ratio. If the central banks reduce the reserve ratio, commercial banks keep less money as a reserveand have more money availableto increase the money supply (and vice versa).

The Discount Rate

If commercial banks borrowadditional money from central banks, they pay interest on the amountper the applicablediscount rate. Central banks can change the discount rate to increase or decrease the cost of such borrowings, which eventually impacts the availability of money in the open markets. Changes in discount ratesare widely followed across the globe to control the money supply.

The Bottom Line

Some of the measures used by China to check money supply apply globally to all countries,whilesome are uniqueto China.Asa fusion of a socialist and free-market economy, China has devised its own processes to keep a firm grip on its economy. China isestablishedas a financial superpower, and, through its controlled measures, it is experiencing economic growth.