How does China peg the yuan to the dollar?

Answer 1

Supply and demand will cause all Fiat currencies to rise and fall in value depending on how much effort humans are willing to spend in order to acquire that currency. This is a universal law that cannot be broken.

However, governments can 'peg' their currency to another currency if they want. That Government has to watch the exchange rate between their currency and the pegged currency very closely.

If a group of workers in a city collectively decide for themselves that the yuan they own is worth more than the 6 dollars they would get in exchange for it, then the currency becomes more valuable. Immediately value has gone up and no law can stop that. The government must work to cause and equal and opposite reaction to get those workers to think that the Yuan is worth less. Governments have many tools to do this.

The national bank of the government doing the pegging must hold large reserves of the foreign currency to mitigate changes in supply and demand. If a sudden demand for a currency were to drive up the exchange rate, the national bank would have to release enough of that currency into the market to meet the demand. They can also buy up currency if low demand is lowering exchange rates.

The government entity that coins money is told to "create more money from thin air" and gives that money to banks in the form of low interest loans. Thus flooding the market with currency as bankers make high risk investments, making currency easier to come by for workers, money becomes easy to get, the value goes down as a result.

The government can do the opposite, refraining from giving more money to the banks, making the banks take less high risk investments, money becomes harder to get, people re-value the currency.

The government uses this like a gas petal on a car, to keep the speed the same, you must press harder when your going up a hill, and press less when your going down a hill.

If the government stops doing this, the currency will immediately fluctuate and will no longer be pegged.