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Yuan could use more loosening up

On the evening of July 21, China's Xinhua News Agency announced that the People's Bank of China had completed its yuan exchange-rate reform, thus putting an end to two years of confusion over the matter. Avoiding the term "revaluation," however, China instead called it "reform."

Moving from a peg to the US dollar to a more flexible exchange rate linked to a basket of currencies is obviously a reform of sorts. As for the managed floating exchange-rate system, the daily trading price of the US dollar against the yuan in the inter-bank foreign exchange market will continue to be allowed to float within a band of 0.3 percent of the central parity published by the People's Bank of China after the previous trading day's close.

This means that China is still controlling its currency's exchange rate, and that there is still a long way to go before we get a reformed and freely-floating exchange rate.

The US dollar to yuan exchange rate set the evening of July 21 was a revaluation of 2.1 percent from the price at the close of the trading day.

One thing that was left out of China's announcement was that this decision was a result of pressure from the international community. The main pressure to revalue the yuan over the past two years has come from the US. It has not been an unreasonable demand, nor will the results only be negative for China.

But because the US made currency revaluation a demand, China reacted by taking an ideological approach and tried to bargain to gain some advantages. Throughout this process, China also took the opportunity to whip up nationalist sentiment.

As a result, Chinese officials, academics and experts have repeatedly claimed that the US' demand amounted to interference in China's domestic affairs and a violation of China's sovereignty.

Some have even said that the US was trying to harm China and block its rise, and that China would be forever doomed if it accepted the demand. Even foreign experts have said that such a reform would not bring any advantage to China or the world.

Following the revaluation, however, all such talk has been replaced by praise. It is understandable that academics and experts on China's payroll would dance to Beijing's tune, but that even foreign experts would do so just shows the efficiency of China's "united front" tactics and the power of business interests.

All this praise also included some voices calling it unexpected, among those a few Hong Kong newspapers who thus indirectly promoted Premier Wen Jiaobao's (溫家寶) talk about a "subtle strategy." But some of us were expecting the change. In an interview on French national radio on the afternoon of July 20 about the Chinese economy, I said I thought the yuan would be revalued because China had put in place a plan for responding to sudden financial changes.

Serious problems in China's financial sector mean that a financial crisis could erupt at any time, and Beijing is worried that an appreciating yuan could set off such a crisis.

The response plan was revealed by Liu Mingkang (劉明康), chairman of China's Banking Regulatory Commission, at a commission meeting called on July 28 to discuss the implementation of a State Council-issued document. The document is still considered a state secret and has not yet been released.

The G8 summit earlier this month should have been an opportunity for the other states to put pressure on China, but the whole issue was avoided, making it obvious that there must have been a tacit agreement not to bring it up.

After the revaluation, Vice Premier Zeng Peiyan (曾培炎) described it as an important step toward deepening the reform of China's financial system and said that it would be beneficial to the long-term development of both the Chinese and global economies.

The reactions from countries around the world have been positive, although financial markets have been distorted as a result of a second round of bomb attacks in London.

The Chinese stock markets -- ?in particular Hong Kong's -- are performing well. Analysts predict that the yuan will appreciate, but argue that because the floating band is too narrow, it should be expanded to at least 10 percent. This has once again sparked nationalist sentiment in China.

The Hong Kong-based Communist Party mouth piece Wenwei Po (文匯報) ran an editorial saying that because Beijing desperately wants to avoid a vicious circle of appreciation, outsiders should not harbor any unrealistic expectations about further loosening. They fear a vicious circle after revaluing the currency by only 2 percent, but in the mid-1990s the yuan depreciated by 57 percent. If that isn't vicious, then what is?

If the US doesn't offer China any advantage, it will not be easy to get them to let the yuan appreciate further. The current revaluation should be considered a gift from China ahead of Hu's visit to the US in September. That visit was originally planned to come after a visit to the UN. The question now is whether, following China's meager gift, the US will now grant his trip the status of an official state visit.

Or maybe this "unexpected" revaluation will manage to set things right again following the uproar over a statement by Major General Zhu Chenghu (朱成虎), dean of the Defense Affairs Institute at the National Defense University.

Zhu said that China could "destroy a couple of hundred US cities" with nuclear weapons if the US attacked China in a conflict over Taiwan. At least the revaluation may serve to divert the media's attention from those remarks.

Regardless, China has joined the WTO, and if it wants to participate in the international community, it must make a transition toward floating its exchange rate.

This also means that China-based Taiwanese businesses must adapt to this situation, or at least start hedging their positions to avoid losses resulting from a fluctuating exchange rate.

A freely floating currency allowing both appreciation and depreciation is a "virtuous circle" and much better than worrying over a vicious circle of appreciation. Sooner or later, that is the road China will have to take, so why not do it sooner rather than later?

Paul Lin is a freelance writer based in New York

Translated by Perry Svensson
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