China makes major shift on currency

In a move that could eventually affect everything from the price of T-shirts in Wal-Mart to the mortgage rates Americans pay, China is moving in the direction of a more flexible currency.

The change, like many things that happen in China, will be gradual and managed. In fact, initially, the Chinese currency will increase in value by only a little over 2 percent. But the Chinese are now committed to letting their currency, the yuan, join the ranks of the other economic powerhouses, Europe and the US, over time.

The Chinese action is a partial victory for the Bush administration which has been encouraging the Chinese to have a more flexible policy. However, it may also help the Chinese economy, one of the world's fastest growing and one in which inflationary pressures are mounting as a result of the huge recent inflow of dollars.

Although the immediate effect of the revaluation will be small, the longer term impact could be more far reaching:

• Long-term interest rates in the US could eventually rise since China is a major buyer of US Treasury securities. In the future, Beijing may not be buying as much US debt. This could increase the interest rates Americans pay for mortgages and slow down the US housing market.

• The US inflation rate might tick up if Chinese goods become more expensive. Some stores, such as Wal-Mart, fill their shelves with products made in China. Their costs will now increase.

• The rise in the value of the Chinese yuan as well as increases in other Asian currencies will give consumers in those countries more buying power. This could potentially mean more jobs for Americans if the US exports more goods.

"It is the beginning of setting a huge snowball in motion," says Axel Merk, who runs Merk Investments, a Palo Alto, Calif., firm that invests in hard currencies. "It will grow bigger and bigger."

In Shanghai, Stephen Green, a senior economist with Standard Chartered Bank, says the Chinese move "is exactly the policy you'd want to see."

He says the Chinese move is motivated mainly by domestic policy. After 11 years of pegging the yuan to the dollar, he says, the policy was undermining the nation's ability to control its monetary policy, foreign exchange was building up, and the central government was having to limit credit growth, hurting bank profitability. "It allows China to adjust to changing conditions through the exchange rate, rather than having to adjust the domestic economy."

The Chinese move, which had been expected to happen in August, was hailed by the Bush administration as "good news for the global economy." Thursday, Treasury Secretary John Snow, who has made several trips to China to push for change, called the new currency program a "very positive development." "We'll continue to closely follow the path of the yuan under this new and reformed regime that they're putting into place," he said.

His remarks were echoed by Fed chairman Alan Greenspan, who termed the Chinese move a "good start." On Wednesday, Mr. Greenspan, in testimony before Congress, said it was in China's interest to allow its currency to move higher.

The Chinese move was greeted mostly as positive in Congress, too. Thursday, Sen. Chuck Schumer (D) of New York, sponsor of legislation that would place a 27.5 percent tariff on all Chinese products, called it a good first step, "albeit a baby step." "It is smaller than we had hoped, but, to paraphrase the Chinese philosophers, the trip of a thousand miles can well begin with the first baby step."

The revaluation comes at a time when China's profile has been growing as an international financial player. Late last year, the giant Chinese computer company, Lenovo, bought IBM's personal-computer business, positioning itself to become more widely known in the electronics market. CNOOC, a state-owned oil firm, made a bold if so far unsuccessful bid for the US oil company Unocal. And Haier, a major appliance maker, just ended its play to take over Maytag. The revaluation of the Chinese currency may result in yet more bids.

"It's going to make our assets cheaper," says Adlai Stevenson III, chairman of the Midwest US-China Association, a non-profit group that is consulting on Chinese investments. "The revaluation ... will support Chinese investment in the United States - not just the purchase of paper but hard assets."

Despite the generally positive response in officialdom, unanswered questions remain about the change. The Chinese, for example, have not indicated which currencies they will use to value their currency and how they will be weighted. In a statement, the National Association of Manufacturers, which has campaigned for the revaluation, said "much depends on how China's new system is allowed to work."

Some analysts think the Chinese might be working in conjunction with other Asian nations. Citigroup, in an analysis of the shift, noted that the Japanese yen and the Singapore dollar had also risen compared to the dollar. And the company expects the Korean won and the New Taiwan dollar to do the same.

"It's possible that behind the scenes they are putting together a basket in consultation with other governments, and you will see other currencies in East Asia pegged to the same basket," says Mr. Stevenson.

In China, the devaluation came as a surprise. Just recently, the government stated that despite American pressure, it would keep the yuan at current levels. But an upcoming visit by Chinese President Hu Jintao to Washington in September could have prompted Beijing to reevaluate. "This puts them on the road and makes them look like they're doing something," says Eric Harwit, professor of Asian Studies at the University of Hawaii.

Professor Harwit says the change in the yuan's value will also help make imports cheaper. This could benefit the burgeoning auto industry, which imports many parts. The move, too, he says, could be part of a bargaining strategy over textiles. Beijing is trying to get the US to ease up on its quotas of textile imports. While Thursday's move is viewed as primarily symbolic, Mr. Harwit doesn't think China is quite ready to fully float the yuan.

"They have to look at the millions and millions of people who need jobs, and if a strong currency puts people out of work, you could have social instability," he says. "That's always going to trump whatever concerns they have about international status."

• Adam Karlin contributed.