In China, the People's Bank of China (PBOC) manages the money supply by printing currency, changing the reserve ratio, and adjusting the discount rate, among other methods.

The second-largest economy in the world, China has a unique socialist open-market economy, with both tight government control and free-market elements. As a manufacturing and export-driven economy, the Chinese currency forex rates also significantly impact money supply.

Understanding Money Supply

Money supply, or money stock, is the total 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 circulation leads 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 economy or for selected sectors. China's money supply policies differ from conventional methods used by other countries because of the country's unique economic system. 

The Traditional Chinese Economy

As a manufacturing and export-driven economy, China runs a trade surplus. It sells more to the world than it purchases. Chinese exporters receive U.S. dollars (USD) for their exports but must pay for local expenses and wages in local currency, the Chinese yuan or renminbi (RMB). Due to the huge supply of U.S. dollars and 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 problematic for the Chinese economy, potentially resulting in lower sales of manufactured goods, widespread unemployment, and economic stagnation. The PBOC intervenes to avoid this situation, keeping the exchange rates lower through artificial measures.

Changes in the Last Decade

The Chinese money supply in recent times has shown consistent growth, as has the Chinese gross domestic product (GDP).

The relationship between China's currency and the economy is interesting because its export-dependent economic system works differently from thosee 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 period has seen the monetization of a variety of resources and their availability to the open market, which has attracted large-scale foreign investment. The resources include manufactured 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 lending and finally increased the money supply. The money supply has risen significantly over the last 10 years. During high and consistent growth rates, China managed the increasing money supply effectively while keeping the currency rates stable.

How China Controls Its Money Supply

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

Controlling Forex Rates 

One major task of the Chinese central bank, the PBOC, is to absorb the large inflows of foreign capital from China’s trade surplus. The PBOC purchases foreign currency from exporters and issues that currency in local yuan. The PBOC is free to publish any amount of local currency and have it exchanged for forex.

This publishing of local currency notes ensures that forex rates remain fixed or in a tight range. It ensures that Chinese exports remain cheaper, and China maintains its edge as a manufacturing, export-oriented economy. Above all, China tightly 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 create some 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 required amount of domestic currency bonds, which takes away the excess cash from open markets. The PBOC also buys domestic currency bonds to infuse cash in the markets when needed.

Printing Currency

Printing domestic currency is another measure applied by China. The PBOC can print yuan as needed, although this can lead to high inflation. However, China has tight state-dominated controls on its economy, which enables it to control inflation differently compared to other 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 the reserve ratio. If the central banks reduce the reserve ratio, commercial banks keep less money as a reserve and have more money available to increase the money supply (and vice versa).

The Discount Rate

If commercial banks borrow additional money from central banks, they pay interest on the amount per the applicable discount 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 rates are widely followed across the globe to control the money supply.

The Bottom Line

Some of the measures used by China to control money supply apply globally, while others are unique to the country. With an economic system with characteristics drawing from both socialist and free-market economies, China has devised its own processes control money supply. China is established as a financial superpower, and through its controlled measures, it is experiencing economic growth.