With China at G-7, new leverage

A revaluation has been long sought by governments and industry in the US, Japan, and Europe, all facing an onslaught of Chinese exports.

Over the past 25 years, China's economic performance has been spectacular. Growth has been so rapid that a quarter billion Chinese have been pulled out of poverty. China now ranks as the world's second largest economy, if measured by the purchasing power of the yuan. China accounts for roughly 12 percent of world output, almost twice as much as Japan by this measure.

China has $480 billion of US Treasury securities in its international monetary reserves, the result of large trade surpluses with the US. China's huge financial reserves, if switched substantially out of the dollar into the euro or yen, could put upward pressure on United States interest rates as the Treasury strives to finance the huge budget deficit in Washington. Vargo notes, though, that Japan's government ceased buying Treasuries this year, with no apparent effect on US interest rates.

China's likelihood of being accepted into a G-8 club is probably small at this time, because it is not a democracy. But perhaps China could win observer status. "China has to be brought into the tent," says economist Noland.

The Bush administration has been under intense pressure from manufacturers and trade unions to get China to act soon to revalue its currency.

A China Currency Coalition, which includes the industrial, agricultural, and labor associations, last month made a "Section 301 petition," a complaint under US trade law, to the administration charging China with "unreasonable and discriminatory" trade policies. This was rejected. The administration said it was doing everything it can in this regard.

Legislation has also been introduced into Congress that would threaten China with WTO and International Monetary Fund sanctions if it does not float its currency. But the issue is on hold until after Nov. 2 elections.

Noland thinks it would be best for China simply to revalue the yuan by 15 to 25 percent against the dollar, rather than floating its value according to supply and demand on the foreign exchange markets. He warns the yuan might weaken, not strengthen. Vargo talks of a 20 to 40 percent revaluation.

Whatever happens, no one expects the US trade deficit with China to wither away.

And a revaluation would be costly to China. A study by the Center for Economic and Policy Research in Washington finds that a 42 percent yuan revaluation would reduce the value of China's dollar reserves by $171.6 billion - equivalent to 10 percent of China's gross domestic product.

China has contacted the Chicago Mercantile Exchange, talking about procedures for setting up "derivatives" for the yuan, a financial technique allowing business to hedge against changes in the yuan's value.

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