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American jobs vs. China's currency: Is the yuan too high?

The value of China's currency, the yuan, is one of the most hotly contested issues in US-China relations. The US says a high yuan is costing American jobs. But it also keeps consumer items, like TVs and computers, inexpensive. Will China soon adjust the value of its currency?

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Here's how it works: Chinese exporters accumulate US dollars or other currencies from foreign customers. However, they need to pay their Chinese employees and suppliers in yuan.

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Chinese exporters go to China's currency market to swap their dollars for yuan. With thousands of firms doing this, the demand for yuan is high. In a free currency market, this would push up the price of the yuan as demand outpaces supply.

To prevent that from happening, China's central bank increases the market supply of yuan. It sells as many extra yuan as the market wants, targeting a rate of around 6.83 to the US dollar. "It's a massive operation," says Nicholas Lardy, a top expert on China's economy at the Peterson Institute for International Economics in Washington, D.C. "For a big economy like China's, the scale of intervention in the market is without precedent in global history."

Why is China keeping its currency undervalued?

The short answer is that it keeps Chinese exports cheap. That helps Chinese firms make money and keeps China's export-driven factories humming. A cheap yuan also means political stability in a nation where tens of millions of Chinese peasants need jobs.

Economists say China didn't necessarily set out with the goal of a cheap yuan. In the late 1990s, the yuan was pegged to the US dollar at about 8.28 to 1. No one complained then, Mr. Lardy says, because the US dollar was strengthening.

The problems started around 2001, he says, when the US dollar weakened and took the yuan with it. The US and other trading partners watched with concern as China's trade surplus grew and its foreign-exchange reserves ballooned.

By that time, a powerful interest group had formed in China in support of a cheap yuan. This group included big exporters and politicians in China's coastal provinces, Lardy says. China's currency policy fueled export sales, and kept the money rolling in and the economy booming in those regions.

The US has been pushing China to revalue the yuan for years. When might China change its policy?

China has already changed its currency policy once before. In 2005, after a few years of pressure, it allowed the yuan to begin appreciating slowly. (Policy wonks call this a "managed float" policy.) From then until 2008, the yuan quietly gained more than 20 percent against the dollar.

China stopped doing this when the global economic downturn hit. It returned to a de facto peg to the US dollar. It did this to protect its exporters and ensure economic stability amid tough global conditions.

Now, economists say Beijing is waiting for clearer signs of a strong global recovery before going back to the "managed float" policy.

Lardy expects that China may begin allowing the yuan to appreciate against the dollar "in the next few weeks," and that we could see a 4 to 6 percent appreciation against the dollar by the end of the year.

"There are a lot of good domestic reasons for China to allow the renminbi to appreciate," says Lardy, including fighting inflation and helping create more service-sector jobs.

Xie also thinks Beijing may allow the yuan to appreciate this year, but only by a small amount. "China will not be able to make a change big enough to make Americans happy – it's impossible," Xie says.