China has a problem.  It's stunning growth, export-oriented policies, and giant trade-surplus tend to flood its marketplace with foreign currency.  Foreign investors use their Dollars, Pounds, or Euros to buy Yuan to purchase interests in local companies with local currency, and exporters getting paid in those foreign currencies must also convert them to Yuan to make local payments for labor and materials.  If the Chinese imported as much as they exported, there would be no problem, but they don't by a longshot.

If the supply of Yuan were limited, and the demand very high - the price of the currency, it's exchange rate, should go up - dramatically in fact.  But if the Yuan were to rise, relative prices in foreign countries, like the US, would also rise and we would demand and consume less Chinese imports - something the Chinese refuse to permit.  When governments intervene to artificially alter their currency's exchange rates out of trade concerns they become vulnerable to attacks in the currency marketplace which try to exploit the imbalance - like George Soros' famous attack on the British Pound on Black Wednesday.

China defends the Yuan's artificially low price in several ways.  First, it controls the currency exchange market for Yuan.  Until recently, the Yuan was fixed to the dollar, and now it is allowed to fluctuate only a tiny amount per day - though over time those little changes are allowing a very gradual but steady appreciation.  Second, it control the local supply and demand of Yuan by printing money and compelling banks to buy low-interest bonds.  Third, it maintains and is rapidly increasing the world's largest foreign currency reserve in its central bank.  By using the enormous of amount of money it collects to buy, among other things, US Debt, the Chinese have made borrowing cheap, liquidity pleantiful, and arguably lowered global interest rates a significant amount and weakened the effectiveness of the tactics in the Federal Reserve's toolkit.

From Bloomberg:

China's foreign-exchange reserves, the world's largest, climbed to a record $1.33 trillion at the end of June, increasing pressure on the government to allow faster yuan gains.

Currency holdings excluding gold rose 41.6 percent from a year earlier, the People's Bank of China said today on its Web site.

``China's foreign reserves are too big and mopping up the liquidity that fuels inflation and asset bubbles is an administrative headache,'' said Simon Derrick, chief currency strategist at Bank of New York in London. ``Allowing the yuan to rise at a faster pace is what they should do.''

... China's trade surplus surged 87 percent from a year earlier to a record $26.9 billion in June, the customs bureau said yesterday. 

Central bank researchers forecast the world's fastest- growing major economy will expand 10.8 percent this year. The government today revised up its estimate of 2006 growth to 11.1 percent, the fastest in 12 years, from 10.7 percent previously.

... The flood of cash from overseas sales is making it harder for the government to cool inflation, running at a two-year high of 3.4 percent, a stock market that's quadrupled since the start of last year and factory and real estate investments that may lead to overcapacity.

... China owns $414 billion of U.S. Treasuries, the second- largest holding after Japan. As much as 70 percent of the reserves may be in dollar-denominated assets, analysts say.

That means that China owns about 8% of the US Debt owned by the public.

The People's Bank of China limits gains in the yuan by printing money to convert the foreign currencies that exporters derive from overseas sales. It then sells bills to remove the extra local currency from the financial system.

That's a Central Bank techinque called "Sterilization" - which is particularly useful in China when they can simply command banks to turn in their cash deposits and purchase these bills which actually bear negative real interest rates.