The Guardian

London, July 22:

China’s long-awaited but small revaluation of its currency probably heralds the start of a series of revaluations but on its own will make little difference to the huge American trade deficit. Washington, which has been putting intense pressure on the Chinese authorities to revalue the yuan, called the revaluation “encouraging’’, but it was not clear if the 2.1 per cent upward move in the yuan’s value against the dollar, combined with the scrapping of the traditional peg to the dollar, would be sufficient to persuade the US to call off its threatened trade sanctions against China. The central bank in China said that from now on it would have a managed float of the yuan against a basket of currencies rather than a peg to the dollar but it did not say what those currencies were. The new peg leaves the yuan valued at 8.11 to the dollar against 8.28, where it had been for the best part of a decade.

American manufacturers and politicians have long complained that the Chinese authorities have held the currency artificially low to aid its exporters. This, they argue, has contributed to a mammoth $162bn US trade deficit with China as cheap Chinese imports have flooded in. The US had been looking for a much bigger revaluation. The Chinese economy has been growing at 10 per cent for many years and has become the world’s seventh largest. Its accession to the World Trade Organisation in 2001 unleashed a fresh wave of exports to the developed world, which was bound to raise the hackles of domestic producers in the recipient countries. But the revaluation of two per cent will not change the cost advantage Chinese manufacturers enjoy. Wage costs are only four per cent of those in the US, so a revaluation of 20 per cent or even 30 per cent would not lead to a sharp fall in Chinese exports overnight.

Since the scrapping of old quota arrangements on January 1, for instance, Chinese shoe imports to the EU have leapt over 700 per cent. The average wholesale price of a pair of Chinese shoes is one tenth of those made in Italy.

Thus, the Chinese move is more a symbol of its intent to further integrate itself into the world’s financial system than a serious attempt to choke off its own exports. A free float of the yuan is probably years off, given the fragility of China’s financial institutions. The move was as much for political as economic reasons. President Hu Jintao is to visit the US in September and was unlikely to relish being lectured again about the yuan. The Chinese have been holding the yuan down against the dollar by buying billions of dollars and then using them to buy US government bonds. The scale of that buying has been sufficient to hold down bond yields in the US. The dollar fell back on the news yesterday and could well come under renewed downward pressure in the coming months as it will be less in demand from Asian central banks, who will continue to diversify their foreign exchange assets away from dollars.

The Japanese yen and other Asian currencies rose two per cent against the dollar and euro yesterday but the Japanese finance ministry said it was prepared to intervene if the yen moved much further.