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US-China Relations and the Yuan: The View from Asia

Updated On: Jun 28, 2010

This column appeared in TODAY newspaper on 26 June 2010

In Shanghai recently, I dined at a stylish restaurant set amid a row of designer shops. It felt as if I was having dinner in New York's Manhattan district, and when the bill came I realised it was just as expensive.

Over in New York, meanwhile, friends tell me that their summer sales are putting the Great Singapore Sale to shame.

It seems prices in major Chinese cities keep rising, while many in parts of America they are getting more affordable than ever.

The announcement by the People's Bank of China that it will allow more flexibility in the value of the yuan ends the yuan's stable exchange rate with the US dollar, set in July 2008. China will now manage the currency against a weighted basket of currencies, including the greenback, probably with a "creeping peg".

Many expect the currency will appreciate; the only question is how much and how quickly. The move may be the start of the end of China as a cheap destination.

That change is important not just to the two countries. Just about everyone in Asia trades with China and also the US. There are implications not just for the price of goods, but also for exports and competitiveness.

Economic impact aside, however, the primary significance is political.

Tensions have been growing over currency values with the Obama administration and Treasury Secretary Tim Geithner pushing for the yuan's appreciation. China's statement will help keep relations on an even keel ahead of the G-20 meeting this weekend.

But stabilising US-China ties will take more than statements. Many US lawmakers and commentators remain sceptical of how far China will go. When China managed the float between 2005 and 2008, there was only a marginal appreciation. Unless China is seen to do more, American attitudes will harden.

Take Democrat Senator Charles Schumer, for example. The senator has pushed to restrict Chinese imports and was quoted as believing that "only strong legislation will get the Chinese to change".

Despite China's shift, the issue will continue to simmer.

Facing mid-term elections in November, many American politicians will be tempted to bring the issue to a boil to gain votes by hitting out at China. In the wake of the crisis, many Americans are still without jobs and feel that unfair trade and globalisation have been hurting them unfairly. To them, the face of unfair globalisation is Chinese.

That can hurt not just China but the rest of Asia, since the regional production network hubs are around China. Unless China and others in the region move on their currencies, pressure will grow in the US for action against imports from across the Pacific.

But does China really want to appreciate the yuan? A shift to a more flexible rate and a stronger yuan can help reduce imported inflation.

The next step for China may be to adjust its interest rates. This would help curb the housing and other asset bubbles that many see in the current exuberance across the country. The danger is that if this is done too quickly or too harshly, demand and the Chinese economy could be hit. But with growth currently hitting almost 10 per cent, there seems to be room for Beijing to manoeuvre its economy.

Political room for manoeuvre may be trickier. Decades ago, an American Treasury Secretary once quipped about a falling US dollar: "It is our currency, but your problem." This still seems true today so long as the dollar remains the de facto common currency for Asian trade.

It remains to be seen how other Asian countries will position their currencies vis-a-vis the falling US dollar and the rising yuan. But if you think in US dollars, prepare for more expensive dinners in China.