In a Significant Shift, China Raises Value of Its Currency

Facing intense international pressure, China took a crucial first step Thursday toward overhauling its currency system, a move that could help ease U.S.-China tensions but eventually raise costs for everything from toys and fruit juice to homes.

Beijing lifted the value of the yuan by 2.1% against the U.S. dollar, much less than what many American lawmakers had hoped for and too little to alter sales of cheap Chinese goods to the U.S.

But in abandoning a decade-old practice of pegging the yuan to the dollar, China opened the door to further appreciation of its currency, which carries significant implications for itself, the U.S. and the global economy.

A stronger yuan could raise prices of Chinese-made products in the U.S. at a time when the American economy increasingly depends on cheap goods from the Asian nation, analysts said. It also could reduce China’s desire to buy U.S. Treasury securities and thus push up mortgage rates, highlighting China’s influence on the sizzling U.S. housing market, they said. News of China’s move helped send U.S. interest rates higher Thursday.

On the other hand, a steady rise in the yuan would help American businesses selling to China such goods as cotton, copper and soybeans, as it would make those products more affordable to the Chinese. U.S. companies have dramatically boosted their sales in China in recent years, hoping to capitalize on its booming economy and fast-growing consumer society.

Despite the small first step, China’s currency move was welcomed by the Bush administration, Federal Reserve Chairman Alan Greenspan and members of Congress who had threatened sanctions if China failed to revalue the yuan. Critics in Congress had contended that the yuan was undervalued by as much as 40%, giving China an unfair trade advantage and contributing to the bulging U.S. trade deficit.

“Today’s developments are extremely positive,” said U.S. Treasury Secretary John W. Snow, who during a recent visit to Beijing urged Chinese officials to revalue the currency.

Also applauding the action were finance ministers and central bankers from several European and Asian countries, whose fortunes have become increasingly linked to China’s economy.

The action also could benefit China by enhancing the Beijing government’s ability to control its economy, which has become the most important engine of global economic growth along with the United States.

The Chinese government and others are worried that China is growing too fast, increasing risks of a sharp slowdown that would have disastrous consequences in the U.S. and across the globe.

The announcement about the yuan came a day after China reported that its economy continued its rapid expansion in the second quarter, posting growth of 9.5% compared with a year before, with modest inflation and a strengthening consumer sector.

Few analysts expect Beijing to make any quick or big additional adjustments to the yuan, because such moves could destabilize the Chinese economy and threaten the current Communist leadership.

The timing of China’s announcement suggested that officials were trying to quell a rising clamor in Washington over China’s increasing economic and political influence. That has been evidenced recently by congressional opposition, on national security grounds, to a Chinese oil company’s attempt to buy Unocal Corp. and a Pentagon report Tuesday warning of China’s military buildup.

“Hopefully this will defuse some of the China-bashing in Washington,” said Andy Rothman, a former State Department economist who follows China for investment firm CLSA Asia-Pacific Markets in Shanghai. Rothman said he had been expecting a currency policy shift sometime next month, before a U.S. visit in September by President Hu Jintao.

“Given how heated the atmosphere has become within the last few months, this will be seen as a responsible act good for China and good for the international financial system,” said Dali Yang, a China expert at the University of Chicago.

One big question is what the effect will be on many Chinese export companies, which have been a driving force in China’s economic boom. Andy Xie, an economist for Morgan Stanley in Hong Kong, said Chinese manufacturers already were struggling with low profit margins and that a yuan appreciation would intensify those pressures.

The dollar has fallen sharply in recent years against other major currencies, but China has kept a peg of 8.28 yuan to one U.S. dollar since 1994. As of today, the Beijing government announced, the yuan will be valued at 8.11 yuan to a dollar.

Some economists suggested that Beijing could allow a 10% appreciation of the yuan over the next year.

In a somewhat cryptic statement Thursday announcing the change, the government suggested that it would be conservative in adjusting the yuan’s exchange rate.

Starting today, the People’s Bank of China said, the yuan will float within a tight band against a basket of foreign currencies, instead of being pegged solely to the dollar. The central bank, though, didn’t spell out which currencies or explain in detail how the system would operate, except to say policymakers would set the yuan’s trading range daily.

At least one U.S. business group called the action an inconsequential gesture and urged Congress to keep up the pressure on China to make meaningful change in its currency policy.

“We don’t expect a 40% revaluation overnight, but we reject token steps and political manipulation at the whim of the Chinese government,” said Kevin Kearns, president of the U.S. Business and Industry Council, which represents small and medium-size companies.

Retailers such as Wal-Mart, Target and Gap that import low-cost Chinese goods aren’t expected to see a significant effect, according to analysts and company representatives. Tractor maker Caterpillar said the currency revaluation might help it sell more machinery. Bank of America indicated it would press ahead with its recently announced plans to invest $2.5 billion for a 9% stake in a major Chinese bank.

In China, some commodity producers such as Baoshan Iron & Steel, China’s largest steel maker, stand to gain from a loosening of the yuan, as they will be able to buy iron ore and coal at a lower cost.

Sun Bing, chief financial officer at Homemart, one of China’s largest home improvement retail chains, said he hoped that the appreciation of the yuan would lead to a pickup in sales. A stronger yuan should give the Chinese higher purchasing power, and Sun said he might be able to lower prices if he had cheaper access to raw materials from overseas.

A risk for the Chinese economy is the prospect of more speculative investments flowing into China in expectation of a rising yuan. In recent years, many investors, particularly from Hong Kong and Taiwan, have poured billions of dollars into China’s real estate market, essentially betting on the yuan to rise. But that injection of capital has created bubble-like conditions in places such as Shanghai. And further investments could put China at a greater threat for an eventual burst.

“For sure, people will psychologically expect more, and their belief in further yuan revaluation will become stronger,” said Ye Huide, president of the Shanghai Taiwan Investors’ Assn.

Further revaluation will give China greater buying power for such resources as oil, which is costing Beijing dearly as it subsidizes the retail prices of fuel, said Lei Da, director of the international economy department at Renmin University in Beijing. “It will definitely be beneficial to China,” he said.

Beijing’s decision was not entirely attributable to U.S. and foreign pressure, analysts said.

“It plays into American rhetoric, but China knows it’s in its own self-interest to do this,” said Yang, of the University of Chicago. “This shows a subtle but fundamental shift in Chinese foreign policy. They no longer see things always as a zero-sum game. Something the Americans like is not necessarily something they must oppose.”

Lee reported from Seoul and Ni from Beijing.