China’s $3.26 trillion stockpile of foreign exchange (as of Oct 2024) sits far above Japan and Switzerland, but the headline number is only the surface. This article traces how reserves swelled: trade surpluses and capital inflows accelerated in the early 2000s, particularly once markets anticipated RMB revaluation, pushing up both the current and capital accounts. To keep the RMB broadly stable under a crawling-peg regime adopted in 2005, the People’s Bank of China (PBC) repeatedly intervened—buying foreign currency with RMB—thereby expanding the monetary base and, absent countermeasures, risking inflation and currency appreciation.
Enter sterilization: the PBC offsets intervention with contractionary moves to neutralize liquidity. Before 2006, it leaned heavily on issuing central bank bills; as the interest burden rose, it pivoted toward raising required reserve ratios, which jumped from 8.5% in 2006 to 17% by 2008. Through and after the global financial crisis, the toolkit broadened to include (reverse) repos, with volumes surging in 2007–2009; later, as growth slowed, reserve ratios were cut and sterilization intensity eased.
Effectiveness is debated but several studies cited in the article find China’s sterilization has largely worked: the PBC preserved considerable monetary autonomy despite limited exchange-rate flexibility, and headline money and price indicators stayed relatively stable versus swings in net foreign assets. Still, the strategy is boxed in by the “impossible trinity”: tighter exchange-rate control collides with rising capital mobility, forcing continual recalibration of instruments and intensity.
Looking forward, the economists flag new headwinds: slowing reserve accumulation, net capital outflows (including weaker FDI), deflationary pressures at home, and trade frictions abroad. If depreciation risks mount, stronger sterilization may be required to defend the peg—but aggressive tightening could further sap domestic demand. The conclusion: China can likely sustain large reserves and relative currency stability only by flexibly re-mixing tools, reassessing exchange-rate flexibility, and balancing external objectives with the need to revive the domestic economy.
