China, relenting under enormous pressure from the United States, yesterday raised its exchange rate by 2 percent and adopted a more flexible regime that will permit future increases.
The change, China’s first in a decade, sent the dollar plummeting against the Japanese yen, South Korean won and other Asian currencies. Malaysia announced it will follow China’s lead in raising its currency.
While the initial drop in the dollar was too small to reduce the U.S. trade deficit by much, with further declines it eventually may lead to an improvement, analysts said, particularly if other Asian countries officially join in the currency realignment.
In the most dramatic reaction yesterday, U.S. interest rates rose sharply as investors worried that China — a major buyer of U.S. Treasury bonds in recent years — will be purchasing fewer U.S. dollars and securities to maintain a fixed currency.
The jump in interest rates bodes badly for the booming housing market in the U.S., where record sales and soaring home prices have been fed by Asian bond purchases that have helped keep mortgage rates at their lowest levels in decades.
U.S. Treasury Secretary John W. Snow, who has been negotiating the change with leaders in Beijing for two years, said it would be “good for China and good for the global economy.”
Like others who remain wary of China’s intentions, however, he called for “full implementation” of the flexible exchange regime and said: “We’ll obviously want to follow this closely. We’re going to want to monitor it.”
The move comes a month before China’s top leaders are scheduled to meet with President Bush at the White House, and comes after a half year of sharply increased pressure from the administration and members of Congress irritated over the ballooning U.S. deficit with China. That deficit surpassed any other nation and reached an unprecedented $162 billion in the past year.
The Senate overwhelmingly approved a resolution this spring to retaliate with stiff tariffs on all Chinese goods if China continued to link its currency to the dollar. It was seen widely as a first step in a trade war that Federal Reserve Chairman Alan Greenspan warned could have serious consequences for the U.S. economy.
Sen. Charles E. Schumer, New York Democrat and co-author of the Senate resolution, called China’s move yesterday “a good first step. … It’s smaller than we had hoped, but to paraphrase the Chinese philosophers, a trip of a thousand miles can well begin with the first baby step.”
Chinese leaders said they made the change to improve management of their fast-growing economy, not in reaction to U.S. pressure.
Jun Tian, counselor of economic affairs at the Chinese Embassy, called retaliatory measures in Congress “counterproductive” and said they “actually delayed our measure. … We understand what is going on on the Hill is pure politics.”
Mr. Greenspan has stressed that China needed to make the change for internal reasons, to avoid out-of-control economic growth and inflation. He hailed China’s announcement yesterday as “a good start” and said he expects further adjustments.
The Fed chairman and other economists caution, however, that even a much bigger currency realignment would not cure the nation’s $660 billion trade deficit, which results from Americans’ consuming substantially more than they produce each year.
If the increased currency costs filter through to consumers, the price of Chinese-made goods, which have been famously cheap in the United States for years, will start to creep up. Big discount stores like Wal-Mart that rely heavily on China to produce bargain goods will suffer.
For China, the change may cool its torrid pace of exports and economic growth somewhat. But the increased purchasing power also will help hold down inflation and lower the cost of imported materials such as oil and copper that feed its manufacturing base.
By weakening the dollar, the change also may promote more attempted takeovers of U.S. firms and other assets by the Chinese, like the proposed purchase of Unocal by China’s government-owned oil company last month.
The People’s Bank of China, in announcing the change, said its goal is to “enhance the independence and efficiency of monetary policy and help bring imports and exports into balance.”
Because China’s economy has emerged as one of the biggest in the world, after growth near 10 percent per year in the decade since it first set the yuan at 8.28 to the dollar, economists estimate that its currency is undervalued by 15 percent to 40 percent.
The revaluation to 8.11 per dollar yesterday could be followed by further adjustments of as much as 1 percent per month under the new regime, which allows the yuan to move up by as much as 0.3 percent per day against 10 other currencies, including the dollar, analysts said.
But just how big the change would be was not clear, since China did not disclose all the details of its new regime and appeared to be intentionally vague so as to retain control over the process.