China frees yuan from dollar. So?
Jul 29, 2005 12:00 PM, Forrest Laws
China's announcement that it is freeing its currency from the dollar and allowing it to “float” against other currencies did not set off mad stampedes on Wall Street.
Nor did it do much to appease growing criticism of China's economic policies, including its alleged currency manipulation that observers credit with making Chinese textile products 30 percent to 40 percent cheaper than U.S. products.
In some respects, the move was much like China's decision last fall to impose tariffs on textile exports — much sound and fury signifying nothing. It also bought time while Chinese firms continued to solidify the inroads they were making into U.S. markets.
Those tariffs did not slow the rapid expansion of imports, which grew by more than 1,000 percent in some categories earlier this year, prompting the U.S. textile industry to file more safeguard petitions to try to cool off the Chinese juggernaut.
According to reports, the People's Bank of China raised the value of the yuan by 2 percent to 8.11 to the dollar on July 21. The Chinese central bank also said it would allow the currency to rise or fall by no more than 0.3 percent from the center of the previous day's trading range.
That's called a “managed float,” which means the yuan could rise 6 percent in a month's time or not change at all, depending on what Zhou Xiaochuan, the governor of the bank, decides.
Chinese officials said they would allow the yuan to be pegged to a “basket” of currencies, the method used to determine the value of the Singapore dollar. But no one knows which currencies.
For now, the change is the equivalent of no more than a “rounding error” in China's economic numbers, as one observer put it, but it's also important that it did not produce a more drastic reaction in the world's financial markets.
With its growing trade surplus with the United States ($650 billion in 2004), China has become a major investor in the U.S. markets, holding an estimated $240 billion in U.S. Treasury notes.
China's huge investment is part of official policy aimed at keeping its currency from rising. The question now becomes whether the new policy results in reduced purchases of dollars and a corresponding rise in U.S. interest rates with negative ramifications for the U.S. housing market and consumer spending.
This is particularly worrisome, said author Clyde Prestowitz, an official in the Reagan administration, because the current administration does not have an official policy to deal with it.
“That these (budget) deficits have to be financed by ever more borrowing from abroad, and that this strategy is mortgaging large U.S. assets to foreign lenders, it is argued, should be of no concern because foreigners will continue to put their money in America,” he said.
“But the economic thinking that allows American leaders to take these positions are badly out of touch with reality.”
