China lifts its currency - and US hopes

By setting the yuan higher, China makes its exports costlier, which could ease the US trade deficit.

By , Staff writer of The Christian Science Monitor

The world's most significant trading relationship took a psychologically important turn Monday as China moved to make its exports more expensive.

Chinese officials set a new currency target at slightly less than 8 yuan per dollar - a level it has not seen since a major devaluation in 1994, economists say.

By itself, it will hardly dent the gargantuan US trade deficit, nor will it stem the massive flow of goods across the Pacific from China. But experts say it is a promising move in a tense relationship between two economies that have grown increasingly intertwined.

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America and China have been serving as twin engines of the global economy, helping to fuel worldwide growth of 4 percent or higher for several years straight.

Both have benefited from their soaring bilateral trade, but it has also become a source of growing concern. The worry is that global growth is becoming imbalanced, with China's growth too dependent on exports and the US too dependent on foreign nations to finance its trade deficit by buying dollars, often in the form of Treasury bonds.

Moving the yuan below 8 per dollar is largely a symbolic step, but offers some promise to officials and economists who say that "global imbalances" need to be resolved.

"We hope that breaking the psychological barrier of 8 will portend a [larger move] in the near future," says Frank Vargo, an economist at the National Association of Manufacturers in Washington. "China knows it needs to revalue."

In its daily currency announcement, China's government said Monday that the official exchange rate was 7.9982 yuan per dollar. The exchange rate has been carefully managed, with only marginal room for it to fluctuate beyond where Beijing officials dictate. Also Monday, China issued a vague pledge to make the yuan more responsive to market forces. The comment came in a joint statement following a meeting between financial officials of China and the European Union.

Officials in Beijing have been willing to buy dollars to keep the yuan low, but Mr. Vargo says China can't afford to do so forever. "It's a pretty strong signal if you've got to spend $20 billion a month to keep the currency where it is," he says.

That amount represents roughly the amount of the trade deficit, or current-account gap, that the US has been running with China.

The result has been a flood of inexpensive goods for US consumers, and greater difficulties for an already struggling manufacturing base in the US.

The purchase of US dollars by China's central bank creates a 33 percent subsidy for Chinese exports, estimates Peter Morici, an economist at the University of Maryland.

"Through recession and recovery [since 2001], the manufacturing sector has lost 3 million jobs" in the US, Professor Morici writes in a recent analysis. Had the US followed historic patterns of recovery, "The manufacturing sector should have regained about 2 million of these jobs, especially given the very strong productivity growth."

Economists don't see an exchange-rate shift by China as a panacea for US manufacturers. They would still face tough competition from other Asian nations. A decline in the US dollar could also help to reduce the trade deficit.

But experts also generally see the yuan as overvalued by as much as 20 to 40 percent. If the yuan is allowed to rise by that order of magnitude, the impact on US manufacturers could be significant.

Last July, China made an initial step toward allowing the yuan to strengthen, and indicated a willingness to see it move three-tenths of a percent each day, Vargo says. But since then, the yuan has moved little.

Monday's move, some analysts say, could signal a new willingness by China to allow a stronger upward swing.

It comes just a week after the US Treasury Department resisted domestic pressure to condemn China for intentionally manipulating its currency to promote exports.

In the long run, a stronger yuan could make China's economy more stable and balanced.

Oil would become instantly cheaper, since it is bought and sold in US dollars on world markets. Other imports would also become cheaper to Chinese consumers.

The yuan's new rate is symbolic as much within China as it is for world markets.

"People are going to notice that the first digit is no longer 8," Vargo says. "It may help convince some of the more conservative old-line Chinese leadership that the world is not going to come to an end."

Some fear that a large or sudden rise in the yuan would be a shock to the export sector. But the bigger danger, economists say, is that a failure to strengthen the yuan could slow the spread of prosperity to other parts of the country that have been left behind.

Moreover, all the dollars that China has accumulated as foreign-exchange reserves will lose value in proportion as the yuan strengthens. The longer China waits, the bigger the hit to the value of its own reserves.

The impact may be "very much a mixed bag for Americans," predicts Daniel Griswold of the libertarian Cato Institute in Washington. While manufacturers will gain, US interest rates could be pushed higher if China becomes less of an eager buyer of US Treasury debt.

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