Problem:
I understand that China operates an exchange regime that is best described as a "movable target-band" system. Meaning that while the Peoples Bank of China (PBOC) and the foreign exchange authorities are willing to let the rate against the $US vary within narrow limits, they are also willing to let that bank move. So if they allowed the RMB to appreciate 1%, and then continued it for a year it would be an annual rate of 12%.
So if China continues this for 2 years and accumulates large foreign exchange reserves and continues to do so. What will this do to the overall Chinese balance of payments if the PBOC does nothing? Since these reserves are being accumulated in $US, where would these transactions show up, if at all, on the US balance of payments and if they do show up, are they inflows or outflows in the US BOP? While it is the Federal Reserve that controls interest rates in the US, suppose they didn't. What effect would Chinese accumulation of $US reserves have on interest rates in the US? Even though the PBOC is accumulating large $US reserves, China very much restricts the ability of anyone else converting RMB into $US so as to purchase $US-denominated assets. What would happen if PBOC stopped managing the rate and let it be determined by the market? What would be the consequences for China's current account? For the US current account?