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1. Introduction
“On August 1st, even as Mr. Paulson (US Treasury Secretary) was meeting with Chinese officials, the US Senate’s Banking Committee approved legislation that would narrow the definition of currency manipulation, making it easier to impose trade penalties on China”1. We see this kind of news almost every week. China is manipulating its currency, which results in huge trade imbalance between the U.S. and China. China should be blamed for manufacturing job loss in the U.S. With sluggish American economy and the coming election year, China currency issue will surely be the center of many debates. But few people would talk about the benefits that China is providing to U.S. consumers by supplying massive quantity of cheap products. What is China’s exchange rate policy? How did this policy come into being? What are the impacts of this policy to both domestic and foreign markets? These are among the questions discussed in this paper.

2. Historical Review of China’s Foreign Exchange Policies
China’s foreign exchange policies have experienced four major stages since 1949. The objective of each reform was to incorporate more market mechanism into rate determination.
2.1 Central Planning Era (1950-1978)
Right after its winning of the civil war, the Chinese communist party started its central planning economy. For almost three decades, a small number of state-owned foreign trade corporations controlled most of China’s imports and exports. In 1981, the 10 largest trade corporations accounted for 76.6% of exports and 81.3% of imports in the country (Lin and Schramm, 2003). Under this economy, state planners used exports to generate foreign currencies to support imports. Heavy machineries for the country’s industrialization programs were top priority of imports. All earnings of foreign currencies by exports were surrendered to a centralized state account, which were allocated to importing needs through central planning.