A Bull in China's Shop

In bow to US and markets, Beijing frees up its currency

It's not exactly the fall of the Berlin Wall. But an announcement last week in Beijing could come close to it in history.

On July 21, China set its currency free - free of relying solely on the US dollar to set the value of the yuan.

No longer will the yuan shift in value only when the greenback does. Rather it will be measured against a "basket" of foreign currencies, including the dollar.

In addition, the yuan will be allowed to "float" on a daily trading market - a float that, for now, will be limited. In fact, the immediate rise in the yuan was allowed to be only 2 percent - a small step in practice but a giant leap in concept. [Editor's note: The original version incorrectly stated that the value of the yuan would go down.]

Shedding mercantile ways

Beijing's rulers have thus made another historic and major kowtow to free markets - as well as to pressure from the US Congress to liberalize their mercantile ways of trade further.

A Senate threat to impose tariffs on Chinese imports if the yuan's value was not adjusted probably helped focus the thinking of China's ruling Communist Party Politburo.

Perhaps China wanted to look like a friendly trading partner in time for President Hu Jintao's trip to the United States in September. China's shift on the yuan will help save diplomatic face during that important visit.

And with China's state-backed enterprises snatching up US companies, such as an attempted buyout of oil firm Unocal, Beijing needed to make a big trade concession.

Fixed peg had to go

As it is, China couldn't afford the financial status quo.

With its economy mushrooming on the global stage, the yuan-dollar peg was not sustainable in both economic and diplomatic terms. The Chinese currency was undervalued by an estimated 15 to 25 percent.

That, in turn, has helped make China's exports very inexpensive - great for US consumers - but it has hurried the loss of millions of manufacturing jobs in the US and elsewhere.

The peg also contributed to an out-of-sight US trade deficit - now 7 percent of the American gross national product - which has made the US vulnerable to foreigners, including the Chinese government, buying and selling that US debt.

Before China, US hit up Japan

The US has been here before with another burgeoning Asian economic giant.

In 1985, the US persuaded Japan to shift the value of its currency to slow down the Japanese dominance of many manufacturing markets in the US. Washington felt Japan had taken too much advantage of the American generosity after World War II to keep the US market wide open to Japanese goods and to help keep the yen at artificially low values.

During the cold war, many friendly Asian nations such as Japan enjoyed US trade privileges. Building up those economies was important to the US, and to eventually creating democracies in the region. But by the 1980s, the US rightly began to demand reciprocity in currency trading regimes and in market openings.

While the US hopes China may someday become democratic, right now that prospect is slim. And the US doesn't share Beijing's concern that it needs rapid economic growth to create jobs for its millions of restless peasants and to maintain stability. US sights are set on treating China as an equal trading partner, one that plays by the same open-market rules.

China's decision to unpeg the yuan is a significant step in that direction. Still left unclear, however, is just how much Beijing's central bank will be allowed to let the yuan rise up to its real market value - and thus make Chinese exports more expensive and American imports less expensive.

Under the "managed float" system set up by Beijing last week, the yuan could slowly drop in value by 6 percent a month. By year's end, China should at least reduce the yuan by more than 15 percent in order for the world to see a real crimp in China's price advantage and to end pressure from Congress.

Under the "managed float" system set up by Beijing last week, the yuan could slowly gain in value by 6 percent a month. By year's end, China should at least raise the yuan by more than 15 percent in order for the world to see a real crimp in China's price advantage and to end pressure from Congress.

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