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Why does China’s purchase of U.S. bonds keeps China currency cheap relative to the U.S. dollars?

Can someone please answer the above question in detail. I really want to understand this matter fully. Thank you for helping me.

Best,
Thank you so much for all your answers. Can you please elaborate on how buying US $ agaisnt the yuan keep china currency cheap. Please suggest readings source if you find it to long.

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3 Responses to “Why does China’s purchase of U.S. bonds keeps China currency cheap relative to the U.S. dollars?”

  1. Anjaree Says:
    May 17th, 2010 at 2:10 am

    China is sitting on the mountain of US dollar. It can sell the US dollar against the renminbi almost without limit at any rate it wants. The rate stop moving since 2008 because Chiina has an opinion that it will be more stable by doing so. It should not have any opinion if it let the invisible hand work.

  2. I didn't do it! Says:
    May 17th, 2010 at 2:10 am

    The purchase of Treasury Bonds by the Chinese central bank is the consequence of the cheap currency, not the cause:

    China is an export oriented economy with a huge trade surplus. That means they export more than they import. As a result, the Chinese export companies will receive US$ to pay for the goods and services that they export.

    They need to convert these US$ into the domestic currency, the Yuan (CNY), to pay salaries and raw material. Since China exports more than they import, there will be an excess demand for the domestic currency, pushing the CNY/US$ exchange rate up.

    Such an appreciation of the CNY, however, would make Chinese exports more expensive and make the Chines economy less competitive in the international markets. To avoid such a situation, the Chinese central bank interferes in the foreign exchange markets, buying the excess US$ against the CNY, maintaining a constant exchange rate.

    This results in massive US$ holdings of the Chinese central bank that they need to invest in the international capital markets. The largest and most liquid market with the lowest risk is the US Treasury bond market. This makes the US Treasury bonds the preferred assets for the Chinese to invest their large currency reserves.

  3. David D Says:
    May 17th, 2010 at 2:10 am

    Currency prices are set by supply and demand, just like everything else. Since the U.S. only accepts US dollars for the purchase of its bonds, China must exchange its currency for dollars. In other words, they are creating a huge supply of their currency, and a huge demand for the dollar. This props up the dollar compared to the Yuan.

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