they believe they can counteract the economic forces from their currency peg. The global economic force is simply too overwhelming. It is not a black market, it is simply THE MARKET.
The Fed (will eventually) force the government to unwind the fixed exchange rate policy by exporting inflation. In reality, we want inflation in the U.S. markets to get us out of the recession, but because China has such a strong stance on keeping their exchanged rate fixed, the inflation is bought by the Chinese government in the form of U.S. dollars.
The government can attempt to keep the exchanged rate fixed, but there is a tipping point that will result in rampant inflation of core prices, resulting in the same scenarios they were trying to avoid (political instability and protest). The authoritarian government is too stubborn to realize that they do not have unlimited access to capital.
The end game: China will eventually have to let their currency appreciate, or continue to soak up the inflation that should theoretically be occurring at home.
China keeps their currency exchange rate fixed in a narrow band because:
-they are scared of losing manufacturing jobs to other lower wage economies
- this would result in less jobs, protests and instability
By keeping the currency rate fixed at an artificial level, they are risking rampant inflation as traders and currency speculators will flock to buy the yuan in anticipation of China attempting to crack down on inflation in food/energy/real estate/core goods. Because they are so poor, a disproportionate share of income is spent on food. The 11% increase in food prices will also result in protests, riots and instability if the government allows that to continue.
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