How China Manages its Yuan

To keep the yuan largely stable, the People's Bank of China buys foreign exchange inflows generated by China's trade surplus and foreign investment from commercial banks, resulting in an injection of yuan into the banking system.

The central bank then soaks up excess yuan in the system via open-market operations and higher bank reserve requirements to prevent the money from flowing into the economy and fuelling inflation.

But as long as foreign funds keep flowing into China, the central bank's efforts to soak up liquidity are not entirely effective because the surfeit of yuan in the banking system often leads banks to increase lending.